Flat Rate: Interest on the Full Original Amount
Under the flat-rate method, interest is calculated on the entire original loan amount for the full tenure, regardless of how much you’ve already repaid. This makes the interest calculation simple (similar to simple interest, applied across the whole tenure) but means you keep paying interest on money you’ve technically already returned to the lender.
Reducing Balance: Interest Only on What’s Outstanding
Under the reducing (or diminishing) balance method — the method almost all standard EMI loans actually use — interest is recalculated each period only on the principal still outstanding. As you repay principal, the base for the next interest calculation shrinks, so the interest charged keeps decreasing over the loan’s life even though your EMI stays the same (see this project’s own EMI guide for how that split works month to month).
Why the Same Quoted Rate Isn’t the Same Cost
Because flat rate keeps charging interest on the original amount throughout, a flat rate of, say, 8% typically costs roughly close to double the equivalent reducing-balance rate over a multi-year loan — the exact multiple depends on the tenure. This is precisely why comparing loan offers by their headline rate alone can be misleading unless you also know which method is being used.
How to Tell Which Method Applies
Most standard bank loans (home loans, most personal loans, most vehicle loans) use reducing balance and are usually required to disclose an APR/effective rate for comparison. Some short-term consumer loans, certain vehicle financing schemes, and a few informal lending arrangements use flat rate — often without clearly stating so, which is why explicitly asking "is this flat rate or reducing balance?" before signing a loan agreement is a genuinely useful, concrete question.
Converting Between the Two for Comparison
If you’re quoted a flat rate and want to understand the roughly-equivalent reducing-balance rate for comparison, the safest approach is to ask the lender directly for the effective/reducing-balance-equivalent rate, or calculate the total interest under each method for your specific loan amount and tenure and compare the totals directly, rather than relying on an approximate multiplier.