Flat Rate vs Reducing Balance Calculator
Convert a flat (add-on) interest rate into the equivalent reducing-balance rate (APR) and effective annual rate, with the monthly installment, total interest and how much extra the flat method really costs.
How it works
Flat interest = P × flat rate × months ÷ 12 · installment = (P + flat interest) ÷ n · reducing-balance monthly rate i solves P = installment × [1 − (1 + i)⁻ⁿ] ÷ i · APR = 12 × i · EAR = (1 + i)¹² − 1
A flat (add-on) rate charges interest on the full original loan for the whole term, even though you repay part of the principal every month. Banks, car dealers and microfinance lenders in many countries quote flat rates because they look low; the honest comparison is the reducing-balance rate — the rate on what you actually still owe — which is what an APR, TAE or CAT measures. For typical terms the reducing-balance equivalent is close to double the flat rate.
Worked example
A 10,000 loan at 10% flat for 24 months charges 10,000 × 10% × 2 = 2,000 of interest, so each installment is 12,000 ÷ 24 = 500. The monthly rate that makes 24 payments of 500 worth exactly 10,000 is about 1.513%, so the equivalent reducing-balance rate is 18.16% APR (19.75% effective) — 1.82 times the quoted flat rate. A genuine 10% reducing-balance loan would cost only 1,074.78 in interest, so the flat method adds 925.22.
Sources: Investopedia — Add-on interest · Wikipedia — Annual percentage rate
Frequently asked questions
Why is the reducing-balance rate almost double the flat rate?
On average you owe only about half the original loan over its life, because each installment repays principal. Charging the flat rate on the full amount is therefore roughly like charging twice the rate on the average balance — the exact multiplier rises with the term.
Which rate should I use to compare loans?
Always the reducing-balance (declining-balance) rate, the APR, or the effective annual rate. Two offers quoted as “8% flat” and “14% reducing” are nearly the same price.
Does prepaying a flat-rate loan save interest?
Often very little: many flat-rate contracts compute the payoff with the Rule of 78 or charge the full remaining interest. Ask for the payoff figure in writing before you prepay.
Is a flat rate the same as simple interest?
It is simple interest on the original principal for the full term, added on top at the start. The total interest is the same as simple interest, but because you repay in installments the true rate is much higher.
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Estimates for education and planning, not financial advice. Lenders’ contracts, fees, day-count and rounding rules differ — check the official cost disclosure (APR / TAE / CAT) in your loan or card agreement before deciding.