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Flat vs reducing-balance interest, explained

"2% a month" can mean two very different amounts of money depending on whether the interest is flat or on the reducing balance. Here's the difference, with simple worked examples.

Flat interest

With flat interest, the charge is always calculated on the original principal, even as the borrower repays. The interest per period never changes.

Example: lend ₹1,00,000 at 2% per month flat. Interest is 2% of ₹1,00,000 = ₹2,000 every month, regardless of how much principal has been repaid. Over 12 months that's ₹24,000 of interest.

Flat is common for daily- and weekly-collection loans, where a fixed total is agreed up front and split into equal installments.

Reducing-balance interest

With reducing-balance (the basis for most EMIs), interest is charged only on the outstanding balance, which falls as principal is repaid. So the interest portion shrinks over time.

Example: the same ₹1,00,000 at 2% per month reducing. Month 1 interest is ₹2,000 — but once some principal is repaid and the balance is, say, ₹90,000, the next month's interest is 2% of ₹90,000 = ₹1,800, and so on. The borrower pays less total interest than under flat at the same quoted rate.

See it side by side: ₹1,00,000 over 5 months

Suppose the borrower repays ₹20,000 of principal each month at 2% per month. Flat byaj never moves; reducing byaj falls as the balance does:

Same principal, same 2%/month, same 5-month payoff — yet flat costs ₹10,000 in interest versus ₹6,000 on the reducing balance. That ₹4,000 gap is why the basis matters as much as the rate.

Why the same rate differs

Because flat keeps charging on the full original amount while reducing charges only on what's left, a flat rate costs the borrower more than the same reducing rate. That's why it's worth being clear which one you mean when you agree terms — the headline percentage alone doesn't tell the whole story.

Which should you use?

There's no single right answer — it depends on the kind of lending. Interest-only and EMI loans are usually reducing-balance; daily/weekly collection loans are usually a flat, fixed total. What matters is recording it correctly so the dues are accurate and both sides agree.

How LendBook handles both

LendBook supports both bases, and does the math for you — accurate to the rupee — so you don't recalculate by hand:

• Reducing-balance for EMI and interest-only loans; the interest follows the outstanding balance, including after part-payments and top-ups.
• Flat, fixed total for daily and weekly collection loans, split into equal installments — with the fixed-total terms disclosed clearly.
• An early-payoff figure that reconciles what's actually been collected, so closing a loan never double-charges.

Related guides: Khata, byaj & udhaar How to track money you've lent