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Loans & Borrowing
The Flat Rate Trap
Dealers often quote a "Flat Rate" to make the interest look low. A 10% Flat Rate is actually equivalent to nearly a ~18% Reducing Balance rate because you are charged interest on the full initial principal for the entire tenure, even after you've paid most of it off.
A Flat vs Reducing Rate Loan Calculator is an eye-opening financial tool that exposes the true cost of borrowing. When you take out a personal loan, car loan, or two-wheeler loan, lenders will often quote a "Flat Rate" (e.g., 10%) because it sounds cheap. However, a Flat Rate is fundamentally different—and much more expensive—than the standard "Reducing Balance" rate used for home loans.
In a Flat Rate loan, the interest is calculated on the entire original principal for the entire duration of the loan. Even after you have paid back 90% of the loan over 4 years, you are still being charged interest on the original full amount in year 5.
Flat Interest = Original Principal × Flat Rate × Total Years
In a Reducing Balance loan (also known as Diminishing Balance), interest is calculated only on the outstanding principal. As you pay your EMI each month, your principal decreases, and so does the interest portion of your next EMI. This is the standard, fair way to calculate interest.
Reducing EMI = P × r × (1 + r)^n / ((1 + r)^n - 1)