Flat vs Reducing Rate Calculator – See the True Cost of a Flat-Rate Loan
Car loans, two-wheeler loans, consumer-durable finance and many microfinance loans are often quoted at a flat interest rate (an "add-on rate" in the US). Banks quote a reducing-balance rate. The two numbers look alike but measure different things, so a flat quote nearly always looks cheaper than it is. This calculator converts one into the other, compares a flat quote with a reducing quote, and shows what it would cost to close a flat-rate loan early.
Flat rate vs reducing rate, with an example
A flat rate charges interest on the full amount borrowed for the whole term: interest = P × flat rate × years. Take ₹5,00,000 at 7% flat for 5 years, repaid monthly. The interest is ₹1,75,000, fixed on day one, and the EMI is ₹6,75,000 ÷ 60 = ₹11,250.
A reducing rate charges interest only on what you still owe, so every EMI costs a little less interest than the one before. The reducing rate that produces the same ₹11,250 EMI is 12.504%. At 7% reducing, the same loan would cost only ₹94,035.96 in interest.
Why the reducing rate isn't simply double the flat rate
Both loans charge the same interest per year, ₹35,000 in the example. The flat rate divides it by the amount you borrowed. The reducing rate divides it by the average amount you actually owe, which is ₹2,79,909.23, a little more than half the loan. That is why the true rate is close to, but below, double the flat rate.
The ratio also depends on the tenure. At 7% flat with monthly payments it rises from 1.81× at 1 year to a peak of about 1.84× at 2 years, then falls to 1.79× at 5 years and 1.50× at 20 years. The rule of thumb "double the flat rate" overstates the true rate, and the constant-ratio formula 2mI ÷ (P(n + 1)) overstates it too, because a real loan balance falls slowly at first.
Comparing a flat quote with a bank's reducing quote
Convert the flat quote to its reducing equivalent and compare like with like. Over 3 years, 6.5% flat equals 11.958% reducing, so an 11.5% reducing loan is cheaper, by ₹3,931.88 on ₹5,00,000. The answer can flip with the tenure: the same 6.5% flat quote beats 11.5% reducing for loans of up to 8 months and for loans of 75 months or more. The "Compare two quotes" mode shades those tenures on the chart and gives the break-even flat rate.
Weekly and fortnightly loans
Microfinance loans are often repaid weekly or fortnightly. More frequent payments pay the balance down sooner, so the true rate is even higher: ₹40,000 at 12% flat for one year, repaid weekly, is 22.707% reducing. To compare that with a monthly-EMI bank loan, use the monthly-EMI equivalent the calculator shows (22.873% here).
Closing a flat-rate loan early
A flat loan's total interest is fixed, but the lender still decides how much of each EMI counts as interest. That split sets your payoff amount. The actuarial (reducing-balance) method charges interest only on what you owed. The Rule of 78 (sum of the digits) counts more interest in the early payments, so less principal has been repaid and the payoff is higher. An equal split counts the same interest in every payment and gives the lowest payoff. On long, high-rate loans the Rule of 78 can even make the balance rise for the first few payments.
Why regulators ask for an APR
Because a flat rate hides the real cost, many regulators require lenders to disclose an annual percentage rate (APR) calculated on the reducing balance. For a flat loan with no fees, the APR equals the reducing equivalent this calculator shows. When a lender gives you both numbers, compare offers on the APR.
What this calculator leaves out
- Processing fees, taxes on fees and insurance. Use the APR Calculator or the Loan Comparison Calculator.
- Advance EMIs, common on vehicle loans, which raise the effective rate. In the APR Calculator, enter the advance EMIs as an upfront fee and the remaining EMIs as the number of payments.
- Reducing loans with annual or daily rests, balloon payments, variable rates and moratoriums.
- Part-prepayments, which the EMI Prepayment Calculator handles.
- Payment frequencies other than monthly, fortnightly and weekly.