What is a flat interest rate? Flat vs reducing rate

What a flat rate means

A flat interest rate is charged on the full amount you borrowed, for the whole tenure (the number of months the loan runs). It does not go down as you repay. So even in the last month, you are still paying interest on money you returned long ago.

That is why a flat rate always costs more than the same number quoted as a reducing rate, where interest is charged only on what you still owe.

How it is worked out

The sum is simple, which is part of its appeal:

Interest = loan amount × flat rate × years

Farhan, 41, is offered ₹1,00,000 for 12 months at “12% flat” to buy stock for his shop.

Interest: ₹1,00,000 × 12% × 1 year = ₹12,000
Total to repay: ₹1,12,000
EMI: ₹1,12,000 ÷ 12 = ₹9,333

Now take a reducing rate of 12% on the same loan. The EMI would be ₹8,885 and the interest ₹6,619. So “12% flat” costs Farhan ₹5,381 more than “12% reducing”.

What reducing rate gives the same ₹9,333 EMI? About 21.5% a year. That is the rate Farhan is really paying. Over 24 months, 12% flat works out to about 21.6% reducing, with an EMI of ₹5,167 and ₹24,000 of interest.

Fictional example. The rates are illustrative, not offers. Calculated by Paisavy (the reducing-rate equivalent is the rate whose EMI matches the flat-rate EMI) and rounded. Fees are left out, so the APR would be higher still.

Where you see it

A flat rate may appear on a quote, a dealer’s leaflet or a chat message as “1% per month flat” or “12% p.a. flat”. Sometimes the word “flat” is missing and only the EMI is given. The Key Facts Statement (KFS) is the short loan summary that banks and NBFCs (finance companies that are not banks) must give you before you sign. It shows the APR, the yearly cost including interest and all charges. Whatever way the rate is quoted, the APR shows the real cost.

Common mistakes

Comparing a flat rate with a reducing rate as if they were the same. A 12% flat offer next to a 16% reducing offer can look cheaper. In our example it is not: 12% flat is close to 21.5% reducing.

Reading “1% a month” as 12% a year reducing. If the 1% is charged on the original amount every month, it is a flat rate.

Thinking a flat rate stays cheap on long loans. The gap does not shrink. Our 24-month example came out at about 21.6% reducing.

Expecting big savings from early closure. Ask how the lender works out the amount to close the loan. The answer depends on your agreement.

What to check

Ask in writing: “Is this rate flat or reducing?”
Get the KFS for each offer and compare only the APR and the total repayable.

Got a flat-rate quote? Compare two loan offers converts it into a reducing-rate equivalent and puts it next to another offer.

Frequently asked questions

What is a flat interest rate?

A flat rate charges interest on the full amount you borrowed for the whole loan, even as you pay it back. The sum is loan amount × rate × years. So ₹1,00,000 at 12% flat for one year means ₹12,000 of interest and an EMI of ₹9,333 (an illustrative rate, not an offer). The interest does not fall as your balance goes down.

How do I convert a flat rate to a reducing rate?

Find the reducing rate that gives the same EMI. In our example, 12% flat for 12 months works out to about 21.5% reducing. Over 24 months it is about 21.6%. You don't need to do this by hand. Compare two loan offers converts a flat-rate quote and shows it next to a second offer.

Why does a flat rate look cheaper than it is?

Because the number is smaller than the reducing rate it equals. A 12% flat offer can look better than a 16% reducing one. Yet 12% flat costs about what 21.5% reducing does, since interest is charged on money you have already repaid. The APR in the KFS (Key Facts Statement) shows the yearly cost including fees, whatever way the rate is quoted.

Is 1% per month the same as 12% a year?

Only if the 1% is charged on what you still owe. If it is charged on the original loan amount every month, it is a flat rate of 12% a year. On a one-year loan that costs about the same as a 21.5% reducing rate. Ask the lender in writing whether the rate is flat or reducing, and read the APR in your KFS.