A flat interest rate charges interest on the original loan amount throughout the term. A reducing balance rate charges it on the principal still unpaid. The same annual percentage therefore produces different interest totals under the two methods. Neither the size of one EMI nor the word fixed tells you which calculation is being used.
HDFC Bank's explanation of flat interest sets out both methods. The worked personal loan examples below use an assumed Rs 1 lakh principal, 12% annual interest and 24 monthly payments. They are calculations for this article, not an available loan offer or a claim about a bank's current lending rate.
| Assumed two year loan | Flat method | Monthly reducing balance |
|---|---|---|
| Principal | Rs 1,00,000 | Rs 1,00,000 |
| Annual quoted rate | 12% | 12% |
| Monthly instalment | Rs 5,166.67 | Rs 4,707.35 |
| Total interest, before fees | Rs 24,000 | Rs 12,976.33 |
Flat interest rate calculation with an example
The flat method uses interest = P × a × t, where P is the original principal, a is the annual rate expressed as a decimal, and t is the term in years. Here the calculation is Rs 1,00,000 × 0.12 × 2 = Rs 24,000. Add the principal to get a total repayment of Rs 1,24,000 before any charges.
Divide Rs 1,24,000 by 24 to get Rs 5,166.6667 per month, shown as Rs 5,166.67 after rounding. The interest calculation continues to use the original Rs 1 lakh even after instalments have been paid. That unchanged calculation base is the defining feature of a flat rate.
Reducing balance interest calculation with an example
For equal monthly repayments, EMI = P × r × (1 + r)n ÷ [(1 + r)n - 1]. Here r is the monthly decimal rate and n is the number of payments. The annual 12% becomes 0.12 divided by 12, or 0.01 per month. Substituting P = 1,00,000 and n = 24 gives an unrounded EMI of Rs 4,707.347222.
Multiply that unrounded EMI by 24 and subtract Rs 1 lakh to obtain total interest of Rs 12,976.33, rounded to paise. In the first month, interest is Rs 1,000. The rest of the EMI, about Rs 3,707.35, reduces principal, leaving about Rs 96,292.65. The next month's interest is then calculated on that smaller balance.
This example assumes payments at the end of each monthly period, an unchanged rate and no fees, missed payments or prepayments. Calculations retain precision until the final displayed amount. An actual lender's final instalment may adjust for rounding, payment dates and its contractual calculation conventions.
Is flat interest the same as a fixed interest rate?
No. Flat and reducing describe the balance on which interest is calculated. Fixed and floating describe whether the rate itself stays unchanged or can reset. A reducing balance loan can have a fixed rate while its interest component falls as principal is repaid. A constant EMI is not evidence of flat interest.
Headline rates alone also leave out charges. RBI's Key Facts Statement circular defines annual percentage rate, or APR, as the annual cost of credit including interest and other associated charges. It requires the KFS to include an APR computation sheet and a loan amortisation schedule. Those disclosures answer a different question from the nominal rate: what the loan costs under its stated terms.
For more on repayment documents and calculations, see the home loan EMI example, the explanation of pre EMI interest before full disbursement, and why a credit card minimum payment can leave interest running.
