Flat vs Reducing Rate Comparison
Compare flat rate and reducing balance interest methods to see the real cost difference.
Interest Rate Method Comparison
Enter your loan details to compare flat rate vs reducing balance (diminishing) interest
Understanding Flat Rate vs Reducing Rate
What is Flat Rate Interest?
Flat rate interest is calculated on the original loan amount throughout the entire loan term. Even as you pay down the principal, interest continues to be charged on the full original amount.
Formula: Total Interest = Principal × Rate × Years
This makes the effective interest rate roughly 1.8-2x higher than the stated flat rate.
What is Reducing Balance Interest?
Reducing balance (or diminishing balance) calculates interest only on the outstanding loan balance. As you pay down the principal, the interest portion of your payment decreases.
Also known as: Effective rate, APR, true interest rate
This is the fairer method and is used by most banks for mortgages and personal loans.
Why Flat Rate Appears Cheaper
- A 5% flat rate sounds lower than 9% reducing rate
- Simple calculation makes it seem transparent
- Often used in car financing and hire purchase
- Marketing makes it appear more attractive
- Many borrowers don't understand the difference
Conversion Rule of Thumb
- Effective Rate ≈ Flat Rate × 1.8 to 2.0
- 5% flat ≈ 9-10% effective (reducing)
- 3% flat ≈ 5.5-6% effective
- 7% flat ≈ 13-14% effective
- Always compare using effective rates