Flat Rate vs Reducing Balance Loans: Why the Same Rate Costs Different Amounts

By the SAA Tool editor, an IT support engineer · Last reviewed 1 October 2026 · 6 min read

Two lenders offer you 20,000 over three years at 6%. One loan costs 3,600 in interest and the other about 1,904. Nothing is hidden and neither lender is lying: they simply charge interest in different ways. One uses a flat rate, the other a reducing balance. Once you can convert one into the other, you can compare any two loan offers, whatever currency they're in.

Two ways to charge interest

With a flat rate, interest is worked out once, at the start, on the full amount you borrow, for the whole term:

Interest = Loan amount × Rate × Years

That interest is added to the loan and the total is split into equal monthly payments. The interest charge never falls, even as you pay the loan off. Flat rates are common for car and personal loans in some countries, and Singapore's MoneySense uses a car loan as its flat-rate example.

With a reducing balance (also called monthly rest, and the basis for an APR or effective interest rate), interest is charged each month only on what you still owe. Payments are usually fixed, so as the balance falls, less of each payment goes on interest and more goes on the loan itself. Most mortgages work this way.

The same 6%, two very different costs

The flat figures are easy to check: 20,000 × 0.06 × 3 = 3,600, and (20,000 + 3,600) ÷ 36 = 655.56 a month.

The reducing-balance payment uses the standard loan formula, with r as the monthly rate and n the number of payments:

Payment = Loan × r ÷ (1 − (1 + r)^−n)

Here r = 0.06 ÷ 12 = 0.005 and n = 36, which gives 608.44 a month. Working backwards from the flat loan's 655.56 payment, the flat 6% loan costs the same as a reducing-balance loan at about 11.08% a year.

Why a flat rate looks cheaper than it is

On the flat loan you pay interest on the whole 20,000 for all three years, even though by the final year you owe less than 7,500. Over the term you owe, on average, roughly half the original amount, so the real rate comes out at nearly double the flat one. This table shows the reducing-balance rate that matches a flat rate, for monthly payments and no fees:

A rough rule: multiply a flat rate by about 1.7 to 1.9 to get the true yearly rate. A few examples in other currencies:

• India: ₹500,000 at 10% flat over 3 years costs ₹150,000 in interest, with monthly payments of ₹18,055.56. That's about 17.92% on a reducing balance. At 10% reducing, the payment would be ₹16,133.59 and the interest ₹80,809.37.
• UAE: an AED 80,000 car loan at 3.5% flat over 4 years costs AED 11,200 in interest, or AED 1,900 a month, which is about 6.58% on a reducing balance.
• Singapore: MoneySense shows a S$90,000 car loan at 2.5% flat costing S$15,750 in interest over 7 years and S$11,250 over 5. Over 7 years that works out at about 4.69% on a reducing balance.

APR, EIR and the rules on showing the real rate

Because a flat rate flatters the price, many countries have a standard way to express the full yearly cost of a loan, so that offers can be compared.

• In the United States, the Consumer Financial Protection Bureau explains that the APR is the interest rate plus other fees charged by the lender, such as origination charges, and advises comparing APRs with APRs, not with interest rates.
• In India, the Reserve Bank of India requires a Key Facts Statement with an APR that includes all charges for new retail and MSME term loans sanctioned on or after 1 October 2024.
• In Singapore, the effective interest rate (EIR) is described as the true cost of the loan, and for flat-rate loans it is higher than the advertised rate.

Watch the convention, though. MoneySense's example of a S$1,000 loan with S$200 of interest, repaid in 12 monthly payments of S$100, has an EIR of 41.3%. Our Loan Calculator shows the same loan (a 20% flat rate for 12 months) as about 35.07%, because it gives the monthly rate times 12. Compound that monthly rate over a year, (1 + 0.3507 ÷ 12)^12 − 1, and you get 41.3%. Both figures are right; just compare like with like.

Fees and early repayment

Processing or arrangement fees, compulsory insurance and other charges add to what you pay, which is why APR and EIR figures that include them are the better guide. If you might clear the loan early, ask the lender in writing how the settlement figure is worked out and whether a fee applies. With a flat-rate loan, the interest is fixed at the start, so repaying early may save less than you expect.

How to compare loans with our tools

The Loan Calculator runs in your browser and handles both kinds of rate.

1. Enter the Loan amount and choose your Currency.
2. Type the Interest rate (% a year) and choose the Rate type: Reducing balance (APR) or Flat rate.
3. Enter the Term and choose years or months.
4. Read the Monthly payment, Total interest and Total you pay. For a flat rate, a note shows the matching reducing-balance rate, and the Year by year table shows principal paid, interest paid and the balance left.

Try the example above: 20,000 at 6%, Flat rate, 3 years gives 655.56 a month, 3,600.00 of interest and a note saying it's about 11.08%. Switch to Reducing balance (APR) to see the 608.44 version.

Flat-rate interest is really simple interest, so the Simple Interest Calculator gives the same 3,600 for 20,000 at 6% over 3 years. For home loans, the Mortgage Calculator works on a reducing balance and shows what an extra monthly payment saves. And for the savings side of the same maths, try the Compound Interest Calculator.

Keep the limits in mind. The calculators assume a fixed rate and equal monthly payments, and they leave out fees and insurance. The matching rate is a nominal yearly rate, not an EIR. For a flat loan, the yearly table splits each payment as a reducing-balance loan at the matching rate would, so your lender's statement may divide it differently.

Quick answers

• Is a flat rate always worse? At the same headline number, yes, but a low flat rate can beat a higher reducing one. 20,000 at 3% flat over 3 years costs 1,800 in interest, less than the 1,903.79 at 6% reducing. Compare the matching rate or the total interest.
• What should I ask a lender? The total amount repayable, the APR or EIR including all fees, and the early settlement terms.
• Does a longer term lower the cost? It lowers the monthly payment but usually raises the total interest.
• Which figure do I compare? Reducing-balance rate with reducing-balance rate, or total repaid with total repaid, for the same amount and term.

This guide is general information, not financial advice. Lending rules and disclosure requirements change and differ by country, so read the lender's official terms and check with your country's financial regulator or an adviser before you sign.

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