Flat Rate vs Reducing Rate Loans: Which Costs More?

A loan rate can be a flat rate or a reducing balance rate. The same number can mean a very different cost.

Reducing balance rate

Interest is charged each month on the amount you still owe. As you repay, the balance falls and so does the interest.

The monthly payment (EMI) is: P × r × (1 + r)^n ÷ ((1 + r)^n − 1), where P is the loan, r is the monthly rate (annual rate ÷ 12) and n is the number of months.

Flat rate

Interest is charged on the original amount for the whole term, even as you repay it.

The monthly payment is: (P + P × annual rate × years) ÷ months.

Side by side

A loan of AED 100,000 over 3 years at 5%:

	Flat 5%	Reducing 5%
Monthly payment	AED 3,194.44	AED 2,997.09
Total interest	AED 15,000	AED 7,895

The flat rate costs almost double the interest. A 5% flat rate over three years works out to an effective reducing rate of about 9.3%.

How to compare offers

1. Check whether each rate is flat or reducing. The loan offer should say.
2. Compare the total repayment, not just the monthly amount.
3. Ask about processing fees, insurance and early settlement charges. They are not in the EMI.
4. A shorter term raises the monthly payment but lowers the total interest.

Calculate it

The EMI calculator handles both types. Enter the amount, rate and term, then switch between flat and reducing.

Your lender’s figures apply.