Accounting
Flat rate and reducing balance: why 10% flat is really about 18%
CA Himanshu Sharma · 2026-10-09 · 6 min read (estimated)
Two lenders quote the same borrower. One says 10%, the other says 18%, and the instalment is the same to within a few rupees. Neither is lying.
The first is quoting a flat rate and the second a reducing-balance rate, and the gap between them is not a margin or a negotiation — it is the same money described two ways. A borrower who compares the two numbers rather than the two instalments reaches the wrong answer every time, and so does a lender who prices against a competitor's quoted rate without asking which basis it is on.
What each one actually charges
Reducing balance charges interest on what is still owed. Month one's interest is computed on the full principal; by month thirty-six it is computed on whatever is left, which is very little. This is how an ordinary EMI loan works and it is what the word "interest" means in almost every regulatory text.
Flat charges interest on the original principal for the whole tenure, regardless of how much has been repaid. A borrower who has repaid 95% of the loan is still paying interest on 100% of it in the final month.
That single difference is the whole of it.
The arithmetic, on a real loan
₹1,00,000 for three years at 10% flat:
- Interest = ₹1,00,000 × 10% × 3 = ₹30,000
- Total repayable = ₹1,30,000
- EMI = ₹1,30,000 ÷ 36 = ₹3,611.11
Now ask the other question: what reducing-balance rate produces that same instalment?
| Reducing rate | EMI on ₹1,00,000 over 36 months |
|---|---|
| 10.00% | ₹3,226.72 |
| 17.00% | ₹3,565.27 |
| 17.50% | ₹3,590.21 |
| 17.92% | ₹3,611.11 |
10% flat is 17.92% reducing. Not approximately, not arguably — the same cash flows.
The ratio is remarkably stable, which makes it a usable rule
The multiple barely moves across amounts and tenures:
| Loan | Flat | Tenure | EMI | Reducing equivalent | Multiple |
|---|---|---|---|---|---|
| ₹1,00,000 | 10% | 3 years | ₹3,611.11 | 17.92% | ×1.79 |
| ₹1,00,000 | 12% | 2 years | ₹5,166.67 | 21.57% | ×1.80 |
| ₹5,00,000 | 8% | 5 years | ₹11,666.67 | 14.13% | ×1.77 |
| ₹2,00,000 | 14% | 1 year | ₹19,000.00 | 24.91% | ×1.78 |
Multiply a flat rate by about 1.8 and you have the reducing-balance rate, near enough for a conversation. It drifts a little with tenure — longer tenures sit slightly lower because more of the principal is outstanding for longer — but between one and five years it stays close to 1.8.
The ratio is not a coincidence. Over the life of an amortising loan the average outstanding balance is a little over half the original principal, so charging on the full principal throughout costs roughly twice what charging on the balance would. The 1.8 is that "roughly twice", pulled down a little by the time value of the instalments.
Where this stops being arithmetic and becomes disclosure
Flat-rate quoting is not prohibited and it is not dishonest in itself. What matters is which rate the borrower is told, in the document that is meant to tell them.
The Key Facts Statement exists precisely because a headline rate is not a comparable number. It requires an annual percentage rate computed on a prescribed basis, which folds in the fees as well as the interest — see what the KFS must contain and what goes into the APR.
Two consequences follow for a lender writing flat-rate business:
The APR on the KFS will not be the flat rate, and it should not be. A loan quoted at 10% flat with a processing fee will disclose an APR north of 18%. That is the correct disclosure, and a KFS showing 10% against a flat-rate loan is wrong.
The sanction letter, the agreement and the KFS must agree. If one carries the flat rate as though it were the interest rate and another carries the effective rate, the file contradicts itself. Which rate belongs on which document is its own question — the four rates on one loan.
Three places it goes wrong inside a system
1. Storing the quoted rate without storing the basis. A rate field containing 10 with nothing saying whether that is flat or reducing is a figure that will eventually be read the wrong way — by a report, by a return, or by whoever opens the record in two years.
2. Computing a schedule on one basis and disclosing on the other. The schedule is built from the flat calculation, the KFS is generated from a rate field, and the two describe different loans.
3. Treating flat-rate interest as if it amortised. On a flat loan the interest in every instalment is identical by construction — total interest divided by the number of instalments — because it was never computed on a balance. A system that splits a flat-rate EMI using a reducing-balance formula produces a schedule whose components are wrong even though its totals are right, and every downstream figure built on that split inherits it.
The honest way to quote
If you quote flat, say flat. If a borrower asks what it works out to, the answer is the reducing-balance equivalent and you should be able to produce it without hesitating — it is on the Key Facts Statement anyway.
The conversation a lender does not want is the one where the borrower works out the multiple themselves, three months in.
Frequently asked questions
Is a flat rate the same as a reducing-balance rate?
No. A flat rate charges interest on the original principal for the full tenure however much has been repaid; a reducing-balance rate charges it on what is still owed. The same loan quoted both ways gives very different-looking numbers for identical cash flows.
How do I convert a flat rate to a reducing-balance rate?
Multiply by roughly 1.8 for a usable estimate. Exactly: compute the EMI from the flat calculation — principal plus flat interest, divided by the number of instalments — then solve for the reducing-balance rate that produces that same instalment. 10% flat over three years is 17.92% reducing.
Why is the multiple about 1.8 and not 2?
Over an amortising loan's life the average outstanding is a little over half the original principal, so charging on the full principal throughout costs close to twice as much. The time value of the instalments pulls that down slightly, landing it near 1.8 for ordinary tenures.
Can an NBFC quote a flat rate?
Quoting flat is not prohibited. What is required is that the Key Facts Statement disclose an annual percentage rate on the prescribed basis, which will be far above the flat figure — and that the sanction letter, the agreement and the KFS do not contradict each other.
Does the interest component change each month on a flat-rate loan?
No. It is identical in every instalment by construction, because it was never computed on a balance. Splitting a flat-rate EMI with a reducing-balance formula produces a schedule whose components are wrong even where its totals are right.
Related: What the Key Facts Statement must contain · What goes into the APR · Which rate goes on which document · Why a loan keeps the terms it was sanctioned under · EMI calculator
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