Flat Rate vs Reducing Balance: How to Work Out the Real Cost of a Loan in Malaysia
Flat rate vs reducing balance comes down to what the interest is charged on. A flat rate charges interest on the original loan amount for the whole tenure. A reducing balance rate charges interest only on what you still owe. With the same headline rate and tenure, a flat rate loan always costs more in total.
Loan offers in Malaysia are often quoted as a single percentage, and it is easy to assume two offers at the same number cost the same. They do not, unless they use the same calculation method.
This guide shows both methods step by step, with two worked examples, so you can check any offer yourself before you sign.
Key takeaways
- A flat rate charges interest on the original principal for the full tenure, so the interest each month never falls.
- A reducing balance rate charges interest on the outstanding balance, so the interest portion falls as you repay.
- At the same headline rate, a flat rate costs noticeably more. In our first example the gap is about RM9,171.
- A flat rate can be converted into an equivalent reducing balance rate, which is usually far higher than the flat figure.
- Always compare offers on total repayment and monthly instalment, not on the percentage alone.
On this page
- What is a flat rate loan?
- What is a reducing balance loan?
- Flat rate vs reducing balance: two worked examples
- Why a flat rate looks cheaper than it is
- How to check the real cost of any loan offer
- Which method is better for borrowers?
- How Northern SME can help
- Frequently asked questions
What is a flat rate loan?
With a flat rate, the lender works out the interest once, at the start, using the full loan amount. That interest is then added to the principal and divided equally across every instalment.
The calculation is simple: interest equals principal × annual rate × number of years. Because the principal used in the sum never changes, you pay interest on money you have already repaid. Flat rates are common for hire purchase and many personal and small business loans.
The flat rate formula
- Total interest = principal × annual rate × years
- Total repayment = principal + total interest
- Monthly instalment = total repayment ÷ number of months
What is a reducing balance loan?
With a reducing balance loan, interest is calculated each month on the amount still outstanding. Early instalments are mostly interest. As the balance falls, more of each instalment goes towards the principal.
The monthly instalment usually stays the same, and it is found with a standard amortisation formula. Mortgages and many bank term loans work this way.
The reducing balance formula
Monthly instalment = P × r ÷ (1 - (1 + r)-n), where P is the loan amount, r is the annual rate divided by 12, and n is the number of monthly instalments. A spreadsheet PMT function gives the same answer. If any of these terms are unfamiliar, our guide to key loan terms explains them in plain language.
Flat rate vs reducing balance: two worked examples
Both examples below are illustrative. They assume no fees, no late payments and equal monthly instalments. Reducing balance figures use the formula above, with the instalment rounded to two decimal places, so totals are shown as approximate.
Example 1: RM50,000 over 5 years at 8%
| Illustrative example 1 | Flat rate 8% | Reducing balance 8% |
|---|---|---|
| Loan amount | RM50,000 | RM50,000 |
| Tenure | 60 months | 60 months |
| Monthly instalment | RM1,166.67 | RM1,013.82 |
| Total interest | RM20,000.00 | About RM10,829 |
| Total repayment | RM70,000.00 | About RM60,829 |
Flat rate working: RM50,000 × 8% × 5 years = RM20,000 interest. Add the principal to get RM70,000, then divide by 60 to get RM1,166.67 a month.
Reducing balance working: r is 0.08 ÷ 12, about 0.006667, and n is 60. The formula gives RM1,013.82 a month, or about RM60,829 over the tenure. The flat rate version costs about RM9,171 more.
Look at the first month to see why. Under the flat rate, about RM333.33 of each instalment is interest for all 60 months. Under reducing balance, month one interest is also RM333.33 (RM50,000 × 8% ÷ 12), but by month 13 the balance is about RM41,528 and that month's interest is only about RM276.85.
Example 2: RM100,000 over 3 years at 6%
| Illustrative example 2 | Flat rate 6% | Reducing balance 6% |
|---|---|---|
| Loan amount | RM100,000 | RM100,000 |
| Tenure | 36 months | 36 months |
| Monthly instalment | RM3,277.78 | RM3,042.19 |
| Total interest | RM18,000.00 | About RM9,519 |
| Total repayment | RM118,000.00 | About RM109,519 |
Flat rate working: RM100,000 × 6% × 3 years = RM18,000 interest, so the total is RM118,000 and the instalment is RM118,000 ÷ 36 = RM3,277.78. With reducing balance at the same 6%, the instalment is RM3,042.19 and the total interest is about RM9,519, roughly half the flat rate figure.
Why a flat rate looks cheaper than it is
You can turn a flat rate into the reducing balance rate that would produce the same instalment. This is sometimes called the effective or equivalent rate, and it shows the true cost in comparable terms.
In Example 1, an instalment of RM1,166.67 over 60 months on RM50,000 matches a reducing balance rate of about 14.1% a year, not 8%. In Example 2, a 6% flat rate over 36 months matches about 11.1% a year on a reducing balance.
The longer the tenure, the wider the gap tends to be, because you keep paying interest on the full original amount for longer. This is why a flat rate offer should never be compared directly with a reducing balance offer using the headline number.
Rate type is a separate question from method. A loan can be fixed or variable as well as flat or reducing, and our article on fixed vs variable rates covers that choice. For the wider picture on pricing, see how business loan interest rates in Malaysia work.
How to check the real cost of any loan offer
You do not need special software. A calculator or spreadsheet and the figures in the offer are enough.
- Ask the lender in writing whether the rate is flat or reducing balance.
- Note the loan amount, tenure in months and monthly instalment.
- Multiply the instalment by the number of months to get the total repayment.
- Subtract the loan amount to find the total interest.
- Add any fees or charges listed in the offer to get the total cost of borrowing.
- Repeat for every offer and compare the totals side by side.
For example, a hypothetical café owner in George Town comparing two equipment loans could use these six steps in under ten minutes. The offer with the lower headline rate is not always the one with the lower total cost.
Which method is better for borrowers?
For the same headline rate, reducing balance is cheaper. That does not mean every flat rate loan is a bad deal. What matters is the total amount you repay compared with other real offers available to you.
- Flat rate loans are easy to understand because the instalment and total interest are known from day one.
- Reducing balance loans usually cost less in interest and reward early repayment more directly.
- Early settlement terms differ between lenders, so read them before you sign.
- The best choice is the one with a total cost and instalment your cash flow can carry.
Borrow only what you need and can repay. A lower instalment stretched over a longer tenure may feel easier each month, but it usually means more interest overall.
How Northern SME can help
Northern SME is the trading name of BINTANG CASH SDN. BHD., a moneylender licensed by KPKT under licence number WL7536/02/01-4/190528. We serve businesses and individuals in Penang, Kedah, Perlis and Perak.
Our agreements use the prescribed forms, so the rate, total interest and total repayment are set out before you sign, and we are happy to walk you through the numbers. We aim to give decisions within 24 hours for complete applications, terms apply. See our loan options or ask us a question on WhatsApp.
Frequently asked questions
Is a flat rate the same as a reducing balance rate?
No. A flat rate charges interest on the original loan amount for the whole tenure, while a reducing balance rate charges interest on the outstanding balance each month. At the same headline rate and tenure, the flat rate loan costs more in total because the interest never falls as you repay.
How do I convert a flat rate into an equivalent reducing balance rate?
Work out the monthly instalment under the flat rate, then find the reducing balance rate that produces the same instalment over the same tenure. A spreadsheet RATE function does this quickly. In our illustrative example, 8% flat over five years is equivalent to about 14.1% a year on a reducing balance.
Why do lenders quote flat rates?
Flat rates are simple to calculate and explain, and the instalment and total interest are fixed from the start. They are common for hire purchase and many personal loans. The simplicity is useful, but always compare the total repayment with any reducing balance offers before choosing.
Does paying early save more on a reducing balance loan?
Usually, yes, because interest is charged on the outstanding balance, so reducing that balance early cuts future interest. How much you save depends on the early settlement terms in your agreement. Some agreements include conditions or charges for early settlement, so check them before signing.
What is the quickest way to compare two loan offers?
Multiply each monthly instalment by the number of months to get the total repayment, then add any fees. The offer with the lower total cost is cheaper, provided the instalment fits your budget. This method works whatever rate type or calculation method each lender uses.
To talk through the cost of a loan for your situation, message us on WhatsApp or reach us through our contact page.
This article is general information and not financial advice. Terms, rates and eligibility depend on your circumstances and the lender's assessment.