UNDERSTANDING INTEREST RATES IN INDIA IN 2026: FLAT RATE VS. REDUCING BALANCE

• Published on Feb 11, 2026
• Read Time 7 mins
• 

If you’re taking a normal or green loan in India, figuring out how interest rates are calculated is a must. Whether you’re applying for an electric vehicle loan, a solar panel loan, or an MSME business loan, the interest rates printed on the brochure never clearly explain what and how you’ll be paying. What actually matters is how the interest rate is calculated.

Lenders in India use two very different methods:

1. Flat rate interest
2. Reducing balance interest

Both methods can make the same loan appear cheap or expensive, even when the advertised rate is identical.

Why This Matters in India’s Lending Environment

• Many NBFCs offering small EV loans still use a flat interest rate.
• Banks and large lenders offering solar and MSME loans use reducing balance methods.
• Borrowers often compare a flat rate from one lender with a reducing rate from another and end up choosing the wrong product.

What’s Flat Rate Interest?

Flat rate interest means the lender charges interest on the entire original loan amount for the entire tenure. This rule remains the same even though you repay the principal every month. Here’s an example:

Loan amount: ₹1,00,000

Flat rate: 10%

Tenure: 3 years

Interest = 10% × ₹1,00,000 × 3

= ₹30,000 total interest

Even after you’ve repaid half the loan, interest is still calculated on the full ₹1,00,000. Such flat rate interest product options are still common for:

• Electric two-wheeler Loans
• E‑rickshaw and three‑wheeler loans
• Consumer durable loans
• Some small‑ticket rooftop solar loans
• MSME loans

Remember, lenders use it because it makes the loan appear cheaper and simplifies the EMI calculation. Even better, it increases their total interest income.

However, based on the real cost it charges, you’re paying as per the numbers below. This is the most accurate conversion range used by Indian loan comparison platforms today.

• 8% flat ≈ 15–16% reducing balance
• 10% flat ≈ 18–20% reducing balance
• 12% flat ≈ 22–24% reducing balance

Bonus Read: How can rooftop solar loans help MSMEs scale?

What’s Reducing Balance Interest?

Reducing balance interest means interest is charged only on the remaining principal and not the original loan amount. This method is standard for solar loans, MSME or machinery loans, bank-issued EV loans, and C&I renewable energy loans. Moreover, reducing balance is preferred since it lowers total interest and is RBI-aligned, making it easier to compare across lenders.

Here’s an example:

Loan amount: ₹1,00,000

Flat rate: 10%

Tenure: 3 years

Month 1 interest = 10% on ₹1,00,000

Month 6 interest = 10% on ₹85,000

Month 24 interest = 10% on ₹40,000

Thus, your interest payments decrease as you start paying down your principal.

Why Borrowers in India Get Misled?

Because lenders advertise “8% flat rate” vs “14% reducing balance”, borrowers naturally assume that 8% is cheaper. However, in reality, 8% flat equals 15-16% reducing. Here are a few added pointers to avoid getting misled:

• EV borrowers are price-sensitive.
• Flat rate loans appear affordable but cost significantly more over 24-36 months.
• Choose reducing balance if you want a lower total interest, long-term affordability, and a fair calculation.
• Opt for a flat rate only if you need a small loan and prefer simple EMI calculations.
• Compare both loans by checking the total interest payable, processing fees, and prepayment charges.
• Look for reducing balance interest rates if you require predictable repayment schedules.

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FAQs

1. Why do two loans with the same “10% interest rate” cost completely different amounts?

Because one may be using a flat rate and the other a reducing balance. Flat rate charges interest on the full loan amount for the full tenure. Reducing balance charges interest only on what you still owe. This difference can change the total cost by 30–50%

2. How do I know if a lender is using a flat rate or a reducing balance?

Ask directly. In India, lenders are not required to highlight the calculation method in advertisements. A simple question, “Is this flat rate or reducing balance?”, can save you thousands.

3. Why do NBFCs still use a flat rate in 2026?

Because it keeps the EMI low and makes the loan appear cheaper. Flat‑rate loans are easier to market, especially for small EVs, e‑rickshaws, and consumer loans.

4. Do MSME loans ever use a flat rate?

Almost never. MSME loans, especially machinery loans, working capital, and business expansion loans, use reducing balance because the loan amounts are larger and transparency is essential.

5. How does prepayment work under each method?

• Flat rate: Prepayment rarely reduces interest meaningfully because interest is pre‑calculated.
• Reducing balance: Prepayment immediately reduces interest because the principal drops.