Flat rate vs reducing balance: why the interest method matters

When you compare loans, the headline rate is only half the story. The other half is how interest is calculated. The two common methods are flat rate and reducing balance.

Flat rate

Interest is calculated on the original loan amount for the whole period, even though you are paying the loan down every month.

Reducing balance

Interest is calculated each month on the amount you still owe. As you repay, the balance falls and so does the interest.

A worked example

Take a loan of KSh 100,000 at 12% per year, repaid monthly over 12 months:

Same amount, same term, same “12%” — yet the flat-rate loan costs about KSh 5,400 more. Over a year, a 12% flat rate works out to an effective rate of roughly 21–22% on a reducing-balance basis.

Rule of thumb: over a year, a flat rate costs close to twice as much interest as the same reducing-balance rate.

So is a flat rate always worse?

Not necessarily. Flat rates are simple and are common on short loans such as school fees or salary advances, where the difference is small because the period is short. What matters is that you compare like with like.

How to compare loans properly

1. Ask which method is used. Every KISE SACCO product shows whether it is flat or reducing balance.
2. Look at the total repayable, not just the instalment.
3. Include charges such as processing and insurance, which are usually deducted at disbursement.
4. Check the rate period — “per month” and “per annum” are very different.