An EMI is presented as a single number, but two lenders can arrive at the same EMI figure through very different arithmetic. The rate quoted on paper is not always the rate you actually pay. The difference lies in whether interest is calculated on the reducing balance or on a flat basis, and the gap between the two methods is larger than most borrowers assume.
The Reducing Balance Method
Under the reducing balance method, interest is charged only on the principal that remains outstanding at the start of each month. As you repay principal, the base on which interest is calculated shrinks, and so does the interest component of each subsequent EMI, even though the EMI amount itself stays fixed. This is the method used by most scheduled banks for personal loans.
The formula:
EMI = P × r × (1 + r)^n / [(1 + r)^n − 1]
Where:
- P = principal (loan amount)
- r = monthly interest rate (annual rate ÷ 12 ÷ 100)
- n = tenure in months
Worked example. Loan amount ₹5,00,000, interest rate 12% per annum, tenure 36 months.
r = 12 ÷ 12 ÷ 100 = 0.01
(1.01)^36 ≈ 1.4308
EMI = 5,00,000 × 0.01 × 1.4308 ÷ (1.4308 − 1) ≈ ₹16,607
Total repayment over 36 months: 16,607 × 36 ≈ ₹5,97,850 Total interest paid: ≈ ₹97,850
The Flat Rate Method
Under the flat rate method, interest is calculated once, on the full original principal, and applied for the entire tenure, regardless of how much principal has already been repaid. The formula is simpler, which is part of why it is still used by some NBFCs and fintech lenders on short-tenure products.
The formula:
Total Interest = P × R × T
EMI = (P + Total Interest) ÷ n
Where R is the annual flat rate (as a decimal) and T is the tenure in years.
Same inputs, flat method. ₹5,00,000 principal, 12% flat rate, 3-year tenure.
Total Interest = 5,00,000 × 0.12 × 3 = ₹1,80,000
EMI = (5,00,000 + 1,80,000) ÷ 36 ≈ ₹18,889
Total repayment: ≈ ₹6,80,000 Total interest paid: ₹1,80,000
The Same Headline Rate, Two Different Costs
Both examples above were quoted at "12% per annum." The reducing balance loan cost ₹97,850 in interest. The flat rate loan, at the identical headline rate, cost ₹1,80,000 — nearly double.
This is not a rounding difference. It is because the flat method keeps charging interest on the original ₹5,00,000 in month 35, even though most of that principal has already been repaid by then. To make the two loans genuinely comparable, the flat rate has to be converted into its reducing balance equivalent. Working backward from the flat-rate EMI of ₹18,889 on the same principal and tenure, the equivalent reducing balance rate comes out to approximately 21% per annum — not 12%.
A loan advertised as "12% flat" is not a 12% loan. It is closer to a 21% loan, once expressed on the same basis as every reducing balance product it is being compared against.
Why This Matters When Comparing Offers
A flat rate is not illegal, and it is not inherently a bad-faith practice. Some lenders use it because it is simpler to compute and administer, particularly on short-tenure or small-ticket products. The problem is comparison: a borrower placing a 12% flat offer next to a 14% reducing balance offer from another lender will, on the face of it, choose the flat-rate loan and pay substantially more.
Since 2025, RBI's digital lending framework requires every lender to issue a Key Fact Statement before sanction, which is meant to state the effective annual cost in a standardised, comparable format regardless of how the underlying interest is structured. This does not remove the need to check it yourself. When comparing two loan offers, the number that matters is the effective interest rate — sometimes labelled APR or Annualised Percentage Rate — not the headline rate printed on the offer.
What to Check Before Accepting an Offer
Ask the lender directly whether the quoted rate is flat or reducing balance. If it is flat, ask for the reducing balance equivalent, or calculate it using the method above. Read the Key Fact Statement for the effective annual rate rather than relying on the number in the marketing material. And compare the total repayment amount across offers, not just the EMI or the headline rate in isolation — the total repayment figure cannot be misrepresented by the choice of calculation method, because it is the actual rupee amount that leaves your account.
The rate a lender quotes is a starting point for comparison, not the final answer. The formula above is the final answer.
Disclosed. Not inferred.