Flat rate vs reducing balance: what your instalment really costs
A 6% flat rate and a 6% reducing-balance rate are not the same price. A worked example on a RM50,000 personal loan over 5 years shows the difference and what to ask the bank.
Two loans can carry the same headline rate and still cost very different amounts. The reason is usually the method used to calculate interest. In Malaysia you will meet two methods most often: the flat rate and the reducing balance. This guide explains how each works, walks through a worked example, and sets out what to ask before you compare offers.
Where you will see each method
- Personal loans are commonly advertised at a flat rate, fixed for the whole tenure. Some banks quote a reducing-balance or effective rate instead, so always ask which method a quoted rate uses.
- Home loans and cash-out refinancing are calculated on a reducing balance. Most are variable, tied to the bank's base rate, so the instalment can change during the tenure.
Because the two methods are not directly comparable, a 6% flat rate and a 6% reducing-balance rate are not the same price.
How a flat rate works
With a flat rate, interest is calculated once, on the original amount borrowed, for the full tenure. That total interest is added to the loan amount and the sum is divided into equal monthly instalments.
The formula is simple: interest = loan amount × rate × years. The monthly instalment is (loan amount + interest) ÷ number of months.
Worked example: RM50,000 over 5 years at 6% flat
This uses the same amount, tenure and rate as the default personal loan example in our instalment estimator, calculated here at a flat rate.
- Total interest: RM50,000 × 6% × 5 = RM15,000
- Total payable: RM50,000 + RM15,000 = RM65,000
- Monthly instalment: RM65,000 ÷ 60 months = RM1,083.33
Notice what happens over time. Every month you repay part of the principal, but the interest is still charged as if you owed the full RM50,000 for all five years. In effect, the interest portion is about RM250 a month (RM15,000 ÷ 60) from the first instalment to the last, even when most of the loan has already been repaid.
How a reducing balance works
With a reducing balance, interest is calculated on the amount still outstanding, usually monthly or daily. Early instalments are mostly interest. As the balance falls, the interest portion shrinks and more of each payment goes towards the principal. The instalment itself is typically level (unless the rate changes), but its make-up shifts over time.
Worked example: RM300,000 over 25 years at 4.20% reducing balance
This is the default cash-out refinance example in our instalment estimator.
- Monthly instalment: about RM1,616.83
- Total payable: about RM485,048.09
- Total interest: about RM185,048.09
In the first month, interest is RM300,000 × 4.20% ÷ 12 = RM1,050, so only about RM566.83 of the instalment reduces the principal. Each month after that, the interest portion is a little smaller and the principal portion a little larger. If the bank's base rate changes, the instalment or the tenure may be adjusted.
The personal loan, calculated on a reducing balance
If the RM50,000 personal loan over 5 years were charged 6% a year on a reducing balance instead, the instalment would be about RM966.64 and the total interest about RM7,998.40. That is roughly half the interest of the flat-rate example, at the same headline figure of 6%.
Converting a flat rate into an effective rate
To compare fairly, you can ask a different question: what reducing-balance rate would produce the same RM1,083.33 instalment on RM50,000 over 5 years? Working it through, the answer is approximately 10.85% a year.
| RM50,000 over 5 years | Monthly instalment | Total interest |
|---|---|---|
| 6.00% flat | RM1,083.33 | RM15,000.00 |
| About 10.85% reducing balance | RM1,083.33 | RM15,000.00 |
| 6.00% reducing balance | RM966.64 | RM7,998.40 |
In other words, a 6% flat rate over five years costs about the same as a 10.85% reducing-balance rate. This is why flat quotes can look lower than they are. The gap between the flat rate and its effective equivalent widens as the tenure gets longer, so a longer loan at the same flat rate is proportionally more expensive than the quoted number suggests.
These figures are rounded and for illustration only. The effective rate a bank discloses may be calculated slightly differently, and it may include other charges.
What this means when you compare offers
- Compare like with like. Ask whether a rate is flat or reducing balance before comparing it with another offer.
- Look at the total payable. The instalment matters for your monthly budget, but the total payable shows the real cost across the tenure.
- Ask for the effective rate. Banks are expected to disclose the key terms of a financing product, and the product disclosure sheet is the right place to find the effective rate, fees and charges.
- Check whether the rate is fixed or variable. A variable reducing-balance rate can move with the bank's base rate, which changes your instalment.
- Consider the tenure carefully. A longer tenure lowers the instalment but increases the total interest you pay.
Early settlement works differently
How much you save by settling early also depends on the method. On a reducing-balance loan, interest is charged on what you still owe, so paying down the balance reduces future interest, subject to any lock-in period or early settlement fee in your agreement.
On a flat-rate loan, the total interest is set at the start. If you settle early, you may be entitled to a rebate of the interest that has not yet been earned, but how that rebate is calculated depends on your agreement and the law that applies to it. Do not assume a figure. Ask the bank for a written settlement statement before you decide.
Try the numbers yourself
Our instalment estimator lets you enter an amount, a tenure and an indicative rate for a cash-out refinance or a personal loan. It uses the reducing-balance method for both. If a bank quotes your personal loan at a flat rate, ask for the effective rate before comparing it with the estimate. The results are estimates only. The actual rate, instalment and approval are always subject to the bank's assessment of your application.
Talk it through with us
If you are weighing up offers and are not sure how they compare, we can walk through the numbers with you and explain what each bank is likely to look at. SMN Capital Solution is a loan consultancy, not a lender, and no fee is charged to submit an enquiry. Send us an enquiry and a consultant will get in touch.
This article is general information, not financial advice. Approval and terms are always decided by the bank.
