Reducing Balance Rate
Interest charged only on the outstanding principal, which falls with every repayment.
Almost all bank loans use reducing balance. A flat-rate quote of the same number is materially more expensive, so always compare on the annual reducing-balance rate or APR.
Why Reducing Balance Rate matters when comparing products
Understanding the reducing balance rate is crucial because it directly impacts the total interest paid over a loan's tenure. Unlike a flat rate, which calculates interest on the original principal throughout, the reducing balance method recalculates interest on the decreasing outstanding principal. This difference can lead to significantly lower overall interest costs, making it a key factor for borrowers to consider when comparing loan offers from various lenders in India.
Illustrative example
Consider a personal loan of ₹1,00,000 for one year at a 10% annual rate. With a reducing balance rate, the interest for each installment is calculated on the remaining principal. If it were a flat rate, interest would be calculated on the full ₹1,00,000 every month. The reducing balance method ensures that as you repay principal, the base for interest calculation shrinks, making it more cost-effective.