Reducing Balance Interest
Also called: reducing balance rate, diminishing balance interest
What is Reducing Balance Interest?
Reducing balance interest is charged on the outstanding principal, which falls with every repayment. As the balance shrinks, so does the interest portion of each instalment.
Why Reducing Balance Interest matters
This is the fair and standard basis for most institutional lending. Comparing a reducing rate against a flat rate as though they were the same makes an expensive loan look cheap.
Reducing Balance Interest formula
Interest for the month = Outstanding principal × Annual rate ÷ 12
Recomputed every month as the principal falls.
How Reducing Balance Interest works in practice
Bank term loans and most regulated lending use reducing balance. When a lender quotes a flat rate instead, ask for the equivalent reducing rate or the total repayable amount before comparing.
Frequently asked questions
At the same quoted number, yes, substantially. The comparison only makes sense after converting to one basis.