A flat rate charges interest on the original principal for the whole term, even as the borrower repays it. A reducing balance (declining balance) rate charges interest only on the principal still owed, so each month’s interest falls as the loan is repaid. On a loan of LKR 100,000.00 at 24% a year, repaid in 12 monthly instalments, the flat method charges LKR 24,000.00 of interest and an instalment of LKR 10,333.33. The reducing-balance method charges LKR 13,471.53 and an instalment of LKR 9,455.96. Both are “24%”, and the flat loan costs the borrower LKR 10,528.47 more.
The two methods
Flat. Work out the interest once, on the amount lent, for the full term: principal × annual rate × term in years. Add it to the principal and divide the total into equal instalments. The borrower pays the same interest in the last month, when they owe almost nothing, as in the first.
Reducing balance. Each month, charge the monthly rate on the balance outstanding at the start of that month. With equal instalments, the instalment is fixed at the start so that it repays the loan exactly by the last month. Early instalments are mostly interest; later ones are mostly principal.
The loan
| Term | Value |
|---|---|
| Principal | LKR 100,000.00 |
| Annual rate | 24% |
| Repayments | 12, monthly |
| Monthly rate | 24% ÷ 12 = 2%, simple and not compounded |
| Period basis | every month counted as one twelfth of a year (30/360) |
| Rounding | to the cent, half up |
The period basis matters. A schedule that charges each month by its actual number of days gives February less interest than March. The instalment stays level, but the split between principal and interest moves from month to month. The figures below use equal months, which is the textbook case and the easiest to check by hand; a later section shows what actual days change.
Flat: the arithmetic
Interest. LKR 100,000.00 × 24% × 1 year = LKR 24,000.00, which is LKR 2,000.00 in every instalment.
Principal. LKR 100,000.00 ÷ 12 = LKR 8,333.333…, which does not divide into cents. Twelve instalments of LKR 8,333.33 repay only LKR 99,999.96, so four cents are left over. A system has to put them somewhere. Here they go one cent each into the first four instalments, which is what splitting by largest remainder does when every share has the same remainder. Other systems put all four cents on the last instalment. Either way the schedule must repay exactly LKR 100,000.00.
| Instalments | Principal (LKR) | Interest (LKR) | Instalment (LKR) |
|---|---|---|---|
| 1 to 4 | 8,333.34 | 2,000.00 | 10,333.34 |
| 5 to 12 | 8,333.33 | 2,000.00 | 10,333.33 |
| Total | 100,000.00 | 24,000.00 | 124,000.00 |
Check: 4 × LKR 10,333.34 + 8 × LKR 10,333.33 = LKR 41,333.36 + LKR 82,666.64 = LKR 124,000.00.
Reducing balance: the arithmetic
The instalment. The level instalment for a loan of P at a periodic rate r over n periods is the annuity formula:
instalment = P × r ÷ (1 − (1 + r)^−n)
With P = 100,000, r = 0.02 and n = 12:
- (1.02)^12 = 1.2682417946
- (1.02)^−12 = 1 ÷ 1.2682417946 = 0.7884931756
- 1 − 0.7884931756 = 0.2115068244
- 100,000 × 0.02 ÷ 0.2115068244 = 9,455.959662, which rounds to LKR 9,455.96
Each month. Interest is 2% of the opening balance, rounded to the cent. Principal is the instalment less that interest. Month 1: 2% of LKR 100,000.00 is LKR 2,000.00, so LKR 7,455.96 goes to principal and LKR 92,544.04 is left. Month 2: 2% of LKR 92,544.04 is LKR 1,850.88, so LKR 7,605.08 goes to principal. And so on:
Sample schedule · LKR · 30/360, equal months, rounding difference on the last instalment
| # | Principal (LKR) | Interest (LKR) | Instalment (LKR) | Balance after (LKR) |
|---|---|---|---|---|
| 1 | 7,455.96 | 2,000.00 | 9,455.96 | 92,544.04 |
| 2 | 7,605.08 | 1,850.88 | 9,455.96 | 84,938.96 |
| 3 | 7,757.18 | 1,698.78 | 9,455.96 | 77,181.78 |
| 4 | 7,912.32 | 1,543.64 | 9,455.96 | 69,269.46 |
| 5 | 8,070.57 | 1,385.39 | 9,455.96 | 61,198.89 |
| 6 | 8,231.98 | 1,223.98 | 9,455.96 | 52,966.91 |
| 7 | 8,396.62 | 1,059.34 | 9,455.96 | 44,570.29 |
| 8 | 8,564.55 | 891.41 | 9,455.96 | 36,005.74 |
| 9 | 8,735.85 | 720.11 | 9,455.96 | 27,269.89 |
| 10 | 8,910.56 | 545.40 | 9,455.96 | 18,359.33 |
| 11 | 9,088.77 | 367.19 | 9,455.96 | 9,270.56 |
| 12 | 9,270.56 | 185.41 | 9,455.97 | 0.00 |
| Total | 100,000.00 | 13,471.53 | 113,471.53 |
After eleven instalments of LKR 9,455.96 the balance is LKR 9,270.56. Its interest for the month is LKR 185.41, so the last instalment is LKR 9,455.97 and the balance closes at exactly zero. The extra cent is the accumulated effect of rounding the instalment and each month’s interest to the cent.
Side by side
| Measure | Flat | Reducing balance | Difference |
|---|---|---|---|
| Monthly instalment (LKR) | 10,333.33 | 9,455.96 | 877.37 |
| Total interest (LKR) | 24,000.00 | 13,471.53 | 10,528.47 |
| Total repaid (LKR) | 124,000.00 | 113,471.53 | 10,528.47 |
| Interest as a share of principal | 24.00% | 13.47% |
The instalments shown are the regular ones; the flat schedule’s first four are a cent higher, and the reducing-balance schedule’s last is a cent higher.
Why the gap is so large
The reducing-balance borrower does not owe LKR 100,000.00 for a year. They owe it for one month, then LKR 92,544.04, and so on down to LKR 9,270.56 in the final month. The twelve opening balances average LKR 56,131.32. Interest at 24% a year for a year on that average is LKR 13,471.52, within a cent of the schedule’s total; the cent comes from rounding each month’s interest.
The flat borrower pays 24% on the full LKR 100,000.00 for the whole year, although on average they owe LKR 56,131.32 of it. That is the whole difference between the two methods.
The same instalment, two rates
Another way to see it: what reducing-balance rate gives the flat loan’s instalment? Solving the annuity formula for an instalment of LKR 10,333.33 gives a rate of 41.70% a year to two decimal places (a nominal rate, 12 times the monthly rate, not compounded). In other words, a flat 24% loan over twelve months costs the borrower the same as a reducing-balance loan at 41.70%. The equivalent rate depends on the term, so work it out for each product rather than applying a rule of thumb.
This is why a flat rate and a reducing-balance rate should never be compared as if they were the same kind of number. When you quote a flat rate, quote the total interest and the instalment beside it.
Equal principal: the third schedule
A reducing-balance loan can also be laid out as equal principal instead of equal instalments. The borrower repays the same principal each month, LKR 8,333.33 with the four leftover cents in the first four months, and the interest falls with the balance. On the same loan the first instalment is LKR 10,333.34, the last is LKR 8,500.00, and total interest is LKR 13,000.00, less than the equal-instalment schedule because principal is repaid faster in the early months. Under a flat rate the two layouts give the same schedule, because flat interest does not depend on the balance.
Conventions that move the figures
Two systems given the same loan can still disagree. When you compare a quote with a spreadsheet, check:
- The period basis. Equal months (30/360) or actual days (Actual/365 or Actual/360). Counting actual days on Actual/365, for a loan disbursed on 1 October 2026, keeps the instalment at LKR 9,455.96 but makes the first month’s interest LKR 2,038.36 for its 31 days. Total interest becomes LKR 13,469.32 and the last instalment LKR 9,453.76.
- Where the rounding difference goes. The first instalment or the last.
- The rounding unit. A lender may round instalments to the nearest LKR 1, 5 or 10 so that cash is easy to count at a centre meeting; one instalment then absorbs the difference.
- How a monthly rate is annualised. 2% a month is 24% a year simply, or 26.82% compounded. State which.
How Fused handles this
Every loan product in Fused says which interest method it uses, flat or declining balance, and whether repayments are equal instalments or equal principal. It also says weekly, fortnightly or monthly repayments, grace periods, one of four day-count conventions, the instalment rounding unit, and whether the rounding difference goes on the first or last instalment. A schedule always repays exactly the principal disbursed. If an instalment would not cover its own interest, the schedule is refused with the reason rather than produced with a growing balance.
An application carries a live quote that is frozen at submission. Products are versioned, and a loan pins the version it was signed under, so a later rate change never reprices it. See lending.
The schedule engine that produces a Fused loan’s instalments also runs the public calculator: price the same loan both ways with the calculator.
To see your own products priced on your own terms, book a walkthrough.