Reducing balance rate
Interest charged only on the loan amount you still owe, so the interest part of each EMI falls as you repay.
A reducing balance rate charges interest only on what you still owe. As you repay, the balance shrinks and so does the interest, which is why each EMI shifts from mostly interest to mostly repayment. It’s the standard method for bank loans. See it worked through in how an EMI works.
Questions people ask
What is a reducing balance interest rate?
It's a way of charging interest only on the part of the loan you haven't repaid yet. Each month, as your balance falls, the interest falls too. Most bank loans, like home and personal loans, work this way.
Is a reducing balance rate better than a flat rate?
At the same quoted number, yes, by a lot. In our illustration, 1 lakh rupees over 3 years costs about 19,600 rupees of interest at 12% reducing, but 36,000 rupees at 12% flat. A 12% flat rate is roughly as costly as a 21% reducing rate.
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