Published on Nov 24, 2021Updated on Sept 17, 2026
Banks and non-banking financial companies (NBFCs) offer various types of loans to fulfill the monetary needs of the applicants. This form of financial aid could include a personal loan, business loan, home loan, or vehicle loan.
Typically, lenders offer borrowers two kinds of interest rate options – reducing balance rate or a flat rate. A proper understanding of the difference between flat and reducing interest rates can prevent unexpected losses.
A flat interest rate is calculated on the full loan amount throughout its tenure. It does not take into account that the principal amount is gradually reduced by the monthly EMIs.
The nominal flat rate that is quoted in the beginning is noticeably lower than the Effective Interest Rate.
Some lenders may offer a flat interest rate, which means that the rate of interest on your mortgage loan will remain the same throughout the tenure of the loan. If there is any reduction in interest rates as a result of market changes, the borrower will not be able to benefit from it. The flat rate of interest is calculated based on the lender’s policy and the borrower’s eligibility.
At SMFG India Credit, mortgage loans are offered at floating rates of interest, which means that the interest rate may change over the tenure of the loan. Our mortgage loans are linked to the retail prime lending rate.
Interest payable/instalment = (interest rate p.a.*no. of years*original loan amount)/number of instalments
Imagine a scenario where you have taken a personal loan of Rs. 1,00,000 for 5 years, or 60 months, at a flat personal loan interest rate of 12%.
Rs. 1,00,000 (principal) × 12% (flat rate of interest) × 5 (number of years) / 60 (number of instalments) = Rs. 1,000 interest per month.
The monthly principal repayment would be Rs. 1,666.67. Adding the interest component, your monthly instalment would be approximately Rs. 2,666.67. Thus, you would pay Rs. 12,000 per year, or Rs. 60,000, as interest over the overall tenure of 5 years.
During the entire repayment tenure, the borrower will end up paying approximately Rs. 1,60,000 (60 × Rs. 2,666.67).
Must Read: Fixed Interest Rates vs Floating Interest Rates - Which is Better?
Easy to Calculate and Track
It is easy to calculate using the flat rate method. Loan commitments that are made using the flat interest rate are transparent. They can be easily tracked by both parties, the borrower and the lender.
Meets the Financial Needs of Farmers
Many borrowers, especially farmers in developing countries, prefer loans with balloon payment options. This is because flat rate calculations are easier to understand.
In-kind Loan Transactions
The flat rate of interest method has been around since before currency was invented. It is the most popular way to repay a loan amount using regular instalments.
An interest rate that is calculated on the outstanding loan amount every month is known as the reducing or diminishing interest rate. In this method, the EMI comprises the principal repayment plus the payable interest on the loan amount that is outstanding.
The outstanding loan amount is reduced after every EMI payment. The interest for the following month is calculated only on the outstanding loan amount.
The reducing balance rate is calculated using the following formula –
Interest payable/installment = Remaining loan amount*Interest rate per installment
Consider an example where a borrower takes a loan of Rs. 1,00,000 for 5 years at a reducing balance interest rate of 12% p.a. Under this method, interest is calculated only on the outstanding principal amount, which decreases as you continue making repayments.
For a Rs. 1,00,000 loan at 12% p.a. for 5 years, the EMI would be approximately Rs. 2,224. In the first year, the borrower would pay approximately Rs. 10,807 as interest, while the outstanding principal at the end of the year would be approximately Rs. 84,118. In the second year, the interest paid would reduce to approximately Rs. 8,797 as the outstanding principal continues to decrease.
In the final year, the interest paid would reduce to approximately Rs. 1,701. Over the entire 5-year tenure, the borrower would repay approximately Rs. 1.33 lakhs, including total interest of approximately Rs. 33,467. This is lower than the Rs. 1.60 lakhs payable under the flat-rate example above.
At SMFG India Credit, we provide a reducing balance rate of interest, thereby enabling you to repay your loan at the best possible price.
The reducing balance interest method is used to calculate interest payable for personal loans, credit cards, overdraft facilities, property loans, mortgages, and housing. Borrowers pay interest only on the outstanding loan amount.
The big advantage that borrowers enjoy when they avail themselves a loan with reducing balance rates is that, over time, they have to pay less interest than flat interest rate loans.
Must Read: Factors that Affects Your Personal Loan Interest Rate
As is evident, simplicity of calculation and low-interest rates do not necessarily make flat rates beneficial. They can be quite misleading when it comes to repaying large loans.
Say you are looking to apply for a personal loan in India. It is advisable to use a personal loan calculatorto find out the interest charges using either option.
If you still have doubts, you can always visit the SMFG India Credit website to know more. Our products and services are uniquely designed to help you meet your financial needs at the most reasonable rates.
Important Note: This article is for general informational purposes only and may be subject to change from time to time. As product features, eligibility criteria, interest rates, charges, fees, tenures and other terms may be revised as per SMFG India Credit's policies, readers are advised to refer to the latest details from the respective product pages (please select from the top menu). For the latest loan charges, please visit Charges & Fees Link and for the latest Interest rates, please visit Interest Rate Rationale. Please note that final loan terms, disbursement process and eligibility criteria will depend on SMFG India Credit's policies at the time of loan application.
The content of this article is for information purposes only and does not constitute as, an offer or advise to avail any products or services from, or, a commitment to grant any loan by the company. It is not intended to create any rights or obligations against us. All content is provided "as is" without any warranty of any kind, either express or implied & we disclaim any warranty or representation, whatsoever, in regards to the content. Please refer to the Privacy Policy of the company to understand the use, processing and storage of your personal data.
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