Flat Interest Rate Vs Reducing Interest Rate: Which is Better?
Reviewed by: Fibe Research Team
- Updated on: 2 Sep 2026
A flat rate of interest differs from a reducing rate, so before you choose a loan, knowing which is better for you is important. Lenders offer various types of interest rates, and a suitable option can lower your borrowing costs.
Read on to understand flat vs reducing interest rates.
Table of Contents
What is a Flat Interest Rate?
A flat interest rate is the rate of interest that remains unchanged through the tenure of the loan. The interest is calculated on the total loan amount at the start of the loan tenure. The financial institution determines the EMI amount and the schedule of repayment.
In this type of interest rate, the interest calculation remains fixed, helping you plan your repayments better. However, keep in mind that the total interest liability is generally higher for flat rates when compared to reducing rates with otherwise comparable loan terms.
Check out the flat interest rate formula:
Flat Interest = (P × R × T)/100
Where:
- P = Principal loan amount
- R = Annual interest rate in percentage
- T = Loan tenure in years
Example of a Flat Interest Rate Calculation
Suppose you take a loan of ₹1 lakh for 12 months at a flat interest rate of 10% per annum.
Flat Interest = (₹1,00,000 × 10 × 1)/100 = ₹10,000
Therefore:
- Principal amount: ₹1,00,000
- Total interest payable: ₹10,000
- Total repayment amount: ₹1,10,000
- Approximate monthly EMI: ₹9,167
Under the flat rate method, interest is calculated on the original ₹1 lakh throughout the loan tenure, even as you repay the loan through EMIs.
What is a Reducing Interest Rate?
A reducing rate is a type of interest calculation in which the interest component reduces as you repay the loan. This is because interest is calculated on the outstanding principal after each repayment rather than on the original loan amount throughout the tenure.
As the outstanding principal decreases with each EMI, the interest charged on it also reduces. This can make the reducing balance method more cost-effective than a comparable flat-rate loan.
Here is the EMI formula for a reducing balance loan:
EMI = [P × r × (1 + r)ⁿ] ÷ [(1 + r)ⁿ − 1]
Where:
- P = Principal loan amount
- r = Monthly interest rate, calculated as annual interest rate ÷ (12 × 100)
- n = Total number of monthly instalments
For example, if the annual interest rate is 10%, the monthly rate (r) would be:
10 ÷ (12 × 100) = 0.008333
The EMI under the reducing balance method remains generally fixed for a fixed-rate loan, but its composition changes over time. The interest component decreases while the principal component increases as the outstanding loan amount reduces.
Also Read: Why Personal Loan Interest Rate is High?
Difference Between Flat and Reducing Interest Rates
Flat and reducing interest rates differ mainly in the amount on which interest is calculated. Understanding these differences can help you evaluate the overall cost of a loan before borrowing.
| Parameter | Flat Interest Rate | Reducing Interest Rate |
|---|---|---|
| Interest Calculation | Interest is calculated on the original principal amount throughout the loan tenure. | Interest is calculated on the outstanding principal after each repayment. |
| EMI | The EMI is generally fixed and is calculated by adding the total flat interest to the principal and dividing it across the repayment tenure. | For a fixed-rate loan, the EMI generally remains fixed, but the interest component reduces and the principal component increases over time. |
| Total Interest Payable | The total interest payable is generally higher because interest continues to be calculated on the original loan amount. | The total interest payable is generally lower for otherwise comparable loan terms because interest is charged only on the outstanding balance. |
| Loan Tenure Impact | A longer tenure directly increases the total interest because the original principal continues to be used for calculating interest throughout the tenure. | A longer tenure can also increase the total interest payable, but interest is calculated only on the outstanding principal at each stage of repayment. |
| Suitable For | Borrowers who prefer a simple and predictable method of calculating their loan interest and repayment amount. | Borrowers looking to minimise their total interest outgo, particularly for larger loan amounts or longer repayment tenures. |
FAQs on Reducing vs Flat Interest Rates
1. What is the formula to calculate a reducing rate of interest?
For a loan that follows the reducing balance method, the standard formula used to calculate the EMI is:
EMI = [P × r × (1 + r)ⁿ] ÷ [(1 + r)ⁿ − 1]
Here, P is the principal loan amount, r is the monthly interest rate and n is the number of monthly instalments.
Under this method, interest for each repayment period is calculated on the outstanding principal. Therefore, as the principal decreases with every EMI, the interest component of subsequent repayments also decreases.
2. Do banks in India use flat interest rate or reducing interest rate for personal loans?
Banks and financial institutions in India may use different interest calculation methods depending on the lender and loan product. Personal loans can be offered using either a flat interest rate or a reducing balance interest rate, although reducing balance calculations are commonly used for EMI-based loans.
Before choosing a personal loan, check whether the quoted rate is flat or reducing. You should also review the Annual Percentage Rate (APR), Key Facts Statement (KFS), EMI amount, applicable charges and total repayment amount to understand the actual cost of borrowing.
3. Which is better: a flat or a reduced interest rate?
A reducing interest rate can generally be more cost-effective because interest is calculated only on the outstanding loan balance. As you repay the principal, the interest component also reduces.
However, the better option depends on the interest rate offered, loan tenure, applicable fees and other repayment terms. Compare the APR and total repayment amount rather than considering only the quoted interest rate before choosing a loan.
