Reducing balance rate or flat rate: why the same number is not the same price

A reducing balance rate charges interest on what is still owed; a flat rate charges it on the whole loan.

Written 08 September 2026. For bankers in India.

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In one line

A reducing balance rate charges interest only on the balance left. A flat rate charges it on the full loan amount.

Why it matters to you

• The same number means two prices. Ten per cent flat and ten per cent reducing are not the same loan.
• A flat quote looks cheap. It is usually about 1.7 to 1.9 times the reducing rate that matches it.
• You may be compared unfairly. A dealer quoting flat can look cheaper than your correct reducing quote.
• The borrower must be told. For covered loans, the key facts sheet must carry the annual cost.
• It changes eligibility. A flat quote gives a bigger instalment, so the income test allows a smaller loan.

How it works

A loan is repaid over months. The balance falls each month. The two methods differ on what the interest is charged on.

Reducing balance. Interest each month is charged on the balance at the start of that month. As the balance falls, the interest falls.

1. Interest for the month is the balance times the yearly rate, divided by 1200.
2. The EMI pays that interest first. The rest reduces the balance.
3. Next month the interest is smaller, because the balance is smaller.

Flat rate. Interest is worked out once, on the full loan, for the whole term. It is then spread evenly.

1. Total interest is the loan amount times the yearly rate times the number of years, divided by 100.
2. The instalment is the loan amount plus that total interest, divided by the number of months.
3. The balance falls every month, but the interest charge never falls with it.

The formulas in symbols.

Flat total interest = P x R x Y / 100

Flat instalment = (P + flat total interest) / n

Reducing EMI = P x r x (1 + r)^n / ((1 + r)^n - 1)

• P is the loan amount, R is the yearly rate in per cent, Y is the term in years.
• n is the term in months. r is R divided by 12, then divided by 100.

Worked examples

Every figure below was computed by machine on 8 September 2026.

Example 1: Rs 5 lakh for 5 years, at ten per cent both ways

• Flat total interest is Rs 5,00,000 times 10 times 5, divided by 100. That is Rs 2,50,000.
• The flat instalment is Rs 7,50,000 divided by 60, which is Rs 12,500.
• The reducing balance EMI at the same 10 per cent is Rs 10,624.
• Reducing balance total interest is Rs 1,37,411, against Rs 2,50,000 on the flat side.
• The flat quote costs Rs 1,12,589 more on the same loan, rate and term.
• Ten per cent flat over five years is the same price as 17.27 per cent reducing.
• Fees are not counted in that figure. The annual cost with fees is higher still.

Example 2: two lenders, and the cheaper one looks dearer

• A borrower wants Rs 3,00,000 for 4 years. Lender A quotes 11 per cent flat.
• Lender B quotes 17 per cent reducing. The borrower thinks lender A is far cheaper.
• Lender A's instalment is Rs 9,000 a month. Total interest is Rs 1,32,000.
• Lender B's EMI is Rs 8,657 a month. Total interest is Rs 1,15,513.
• Lender B is Rs 343 cheaper each month and Rs 16,487 cheaper over the term.
• Eleven per cent flat over four years is really 19.19 per cent reducing.

Example 3: how the gap moves with the term

• Ten per cent flat over 2 years is the same as 18.16 per cent reducing.
• Ten per cent flat over 3 years is the same as 17.92 per cent reducing.
• Ten per cent flat over 5 years is the same as 17.27 per cent reducing.
• Ten per cent flat over 7 years is the same as 16.66 per cent reducing.
• So a flat rate is roughly 1.7 to 1.9 times the matching reducing rate at common terms.

What the rule says

RBI RULE. RBI does not fix any rate for you. It does fix the rest and the disclosure.

• A bank charges interest on all advances at monthly rests. That is paragraph 4(a)(vii) of the Interest Rate on Advances Directions, 2016.
• Rests means how often interest is charged. Monthly rests point to the balance, not to the first amount.
• The key facts sheet circular of 15 April 2024 defines the annual percentage rate. That is the annual cost including charges.
• Paragraph 6 of that circular asks for a rate sheet and the full repayment table.
• Paragraph 11 applies it to new retail and small business term loans from 1 October 2024.
• So a covered borrower must be shown the annual cost, whatever the sales quote looked like.

NO RBI NUMBER. We could not find an RBI rule that bans a flat rate quote. If you know of one, tell us.

BANK PRACTICE. Banks work on reducing balance. A flat quote is met more often in dealer and small ticket finance.

Common mistakes

• Comparing a flat rate with a reducing rate. They are different measures. Convert one before you compare.
• Assuming the lower number is cheaper. In example 2 the higher number is the cheaper loan.
• Believing the flat rate falls as the loan runs. It does not. The charge is fixed at the start.
• Leaving the annual cost off the sheet. For covered loans this is a disclosure failure, not a small slip.
• Testing income on the wrong instalment. Use the instalment the borrower will really pay.
• Trusting a website calculator. We opened one whose own example figures did not agree with each other.

How to use it at your desk

1. Ask the borrower one question first: was the rate quoted flat or on the balance?
2. If it is flat, work out the instalment: loan plus flat interest, divided by the months.
3. Find the reducing rate that gives the same instalment. Your system or a spreadsheet will solve it.
4. Write both rates on the file, so the next reader sees why the numbers differ.
5. Give the borrower the key facts sheet with the annual cost, where the rule covers the loan.
6. If a dealer quote looks far below your own, check the method before you match the price.

Related terms

• EMI — the standard EMI formula is a reducing balance EMI. A flat rate is built another way.
• Moratorium and pre-EMI — pre-EMI is interest on the amount released, so it follows the balance.
• Step-up EMI — a step-up loan is still on the balance. Only the instalment changes over time.
• Bullet payment — in a bullet loan the balance never falls, so both methods agree.
• FOIR — FOIR (Fixed Obligation to Income Ratio) uses the instalment, which a flat quote raises.
• Personal loan rules — the BankPulse page for personal loans, where flat quotes are met.
• MSME loan rules — the BankPulse page for small business loans and their pricing rules.

Quick check

A lender quotes 10 per cent flat for 5 years. What reducing rate matches it?

Answer: About 17.27 per cent. The flat number is roughly 1.7 times the reducing one here.

Which method does a bank use to charge interest on an advance?

Answer: Monthly rests on the balance, under paragraph 4(a)(vii) of the 2016 Directions.

Lender A quotes 11 per cent flat and lender B 17 per cent reducing, for 4 years. Which is cheaper?

Answer: Lender B. On Rs 3,00,000 it saves Rs 343 a month and Rs 16,487 in all.

Sources

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