A quoted 10% can hide two different borrowing costs
A 10% flat rate is not equivalent to a 10% reducing-balance rate. On ₹5 lakh for 5 years, flat interest calculated on the original principal every year is ₹2.5 lakh, giving a payment of about ₹12,500 a month. A 10% reducing-balance EMI is about ₹10,624 a month with roughly ₹1.37 lakh total interest. The identical “10%” headline can therefore hide very different borrowing costs.
Compare cash flows, not percentages
- Flat interest keeps charging the original principal in the simplified formula.
- Reducing-balance interest is calculated on outstanding principal.
- Compare effective annual cost and total repayment, not the headline percentage alone.
- Ask the lender for the APR/effective rate where applicable.
₹5 lakh, 5-year worked comparison
| Method | Monthly payment | Total interest | Total repayment |
|---|---|---|---|
| 10% flat | ₹12,500 | ₹2,50,000 | ₹7,50,000 |
| 10% reducing | ₹10,624 | ₹1,37,411 | ₹6,37,411 |
The flat-rate loan costs more even though both advertisements could show “10%”. This is why comparing only quoted rates can be misleading.
Convert the flat quote into an effective cash-flow cost
For the same ₹5 lakh, 5-year illustration, receiving ₹5 lakh upfront and then paying ₹12,500 at the end of each month for 60 months implies a monthly internal rate of return of about 1.439%. Compounded over 12 months, that is an effective annual cost of about 18.71% before adding processing fees or other compulsory charges. That is why a 10% flat quote should never be compared directly with a 10% reducing-balance quote.
RBI's Key Facts Statement framework defines APR as the annual cost of credit including the interest rate and other charges associated with the credit facility. Where the KFS framework applies, use the lender's disclosed APR and total repayment as the common comparison basis rather than trying to infer cost from a marketing rate alone.
Why flat looks deceptively low
In a flat-rate calculation, interest is based on the original principal for the full tenure even as you repay the loan. In a reducing-balance calculation, interest is recalculated on the amount still owed. The effective cost of a flat-rate loan is therefore substantially higher than its simple headline rate suggests.
What to ask before signing
- Is the quoted rate flat or reducing?
- What is the total rupee repayment?
- What is the effective annualised rate/APR?
- Are processing fees financed or deducted upfront?
- How are prepayments credited to principal?
Use the total-cash-flow test
Put the actual amount you receive on day one and every payment/fee on a dated cash-flow schedule. An annualised IRR on those cash flows is a much better apples-to-apples cost measure than two marketing percentages calculated on different bases.
Put every loan quote on the same economic basis
A flat rate is applied to the original principal for the stated period, while reducing-balance interest is charged on the outstanding principal. Therefore, two loans displaying the same percentage can have very different EMIs and total interest. Compare APR, total repayment and the repayment schedule rather than the headline percentage alone.
Where loan-rate comparisons fail
- Comparing the quoted flat rate directly with a reducing-balance rate.
- Ignoring compulsory fees, insurance or processing charges when comparing total cost.
- Assuming that any loan described with an EMI must use reducing-balance interest.
- Comparing loans with different tenures without normalising the total repayment.
- Accepting a verbal rate quote without an amortisation schedule or all-in disclosure.
Ask for one comparable disclosure
Request the lender's Key Facts Statement or equivalent disclosure showing APR and all-in charges. That gives you a common basis for comparing products that use different marketing conventions. If a salesperson quotes only a flat rate, ask for the effective annual cost and the full amortisation schedule before accepting the offer.
Prepayment terms can change the comparison
A cheaper-looking loan can become less attractive if exit or prepayment charges are materially different. RBI's 2025 Directions, effective for covered loans sanctioned or renewed on or after 1 January 2026, prohibit prepayment charges on specified floating-rate loans to individuals for non-business purposes. Other loan types and circumstances can have different treatment, so read the sanction letter and KFS instead of assuming every loan is penalty-free.
Compare the loan on one basis
Frequently asked questions
Is 10% flat equal to 10% reducing?
No. The flat method is usually much more expensive for the same principal and tenure.
Why is the flat EMI higher here?
The flat method charges the simple interest on the original ₹5 lakh for all five years.
What should I compare across lenders?
Effective annual cost/APR, total repayment, fees, tenure and prepayment terms.
Can a flat-rate loan ever have a lower payment?
It depends on the quoted percentages. The point is that the percentages are not directly comparable.
Does EMI always mean reducing balance?
Do not assume. Confirm the lender’s interest method and repayment schedule.