Fixed vs. Reducing Balance Interest Rates

Two Ways Lenders Charge Interest

1. Flat-Rate (Simple Interest)

Interest is calculated on the original principal for the full tenure — even as you pay it back.

Total Interest = P × R × T ÷ 100

Example: ₹5,00,000 at 12% flat for 3 years:

Total interest = ₹1,80,000

Monthly EMI = ₹18,889

This method is deceptively expensive. The effective annual rate is nearly double the quoted flat rate.

2. Reducing Balance (Diminishing Balance)

Interest is charged only on the outstanding principal after each payment. This is the standard method used by banks for home and personal loans in India. Same example at 12% reducing:

Total interest ≈ ₹96,000

Monthly EMI ≈ ₹16,607

Savings vs. flat rate: ₹84,000

Effective Interest Rate Comparison

Loan Type	Quoted Rate	Effective Cost
Home loan	8.5% reducing	≈ 8.5%
Personal loan	14% reducing	≈ 14%
Personal loan	14% flat	≈ 24–26%
Credit card	2.5%/month	≈ 30% p.a.

Fixed vs. Floating Interest Rates

Fixed rate — locked for the entire tenure. Safer for long-term budgeting; usually 0.5–1% higher than floating. Floating rate — linked to the RBI repo rate or MCLR. Falls when rates drop but rises when rates climb. Best chosen when rates are at cyclical highs.

How to Verify the True Cost

The cheapest way: enter both loans into our EMI calculator and compare the Total Interest Payable figure, not just the EMI.