Flat interest vs. interest on the balance: the real gap
By Equipo Prestafolio
With the exact same numbers, a flat-interest loan can cost the client almost double one on the declining balance. The instalment-by-instalment comparison, plus a calculator to try your own numbers.
With the same amount, the same term and the same "advertised" rate, a flat-interest loan can cost the client almost double the interest of one charged on the declining balance. It is not a trick or fine print: it is the mechanics of how each instalment gets calculated. And if you are a lender, understanding this difference decides whether your 5% monthly is really 5% or closer to 10%.
The two ways to calculate interest
| Flat interest | Interest on the balance |
|---|---|---|
What it is calculated on | The original amount, always | What the client still owes |
How the instalment splits | Same proportion of interest in every instalment | More interest at the start, more principal at the end |
How easy it is to calculate by hand | Very easy: amount × rate × instalments | Needs the annuity formula or a spreadsheet |
Who uses it most | Informal credit, "gota a gota" lenders | Banks, finance companies, the standard French method |
With flat interest, if you lend 10,000 at 5% monthly and the client has already paid half the instalments, you are still charging 5% on the original 10,000, even though in reality they only owe a fraction of that. With interest on the balance, the 5% is calculated on what is actually still outstanding, so it drops instalment after instalment.
The example that makes it clear: 10,000 over 12 monthly instalments at 5%
Same "advertised" rate in both cases: 5% monthly.
Item | Flat interest | Interest on the balance |
|---|---|---|
Total interest | 10,000 × 5% × 12 = 6,000 | 3,539.07 (French method) |
Total to repay | 10,000 + 6,000 = 16,000 | 10,000 + 3,539.07 = 13,539.07 |
Monthly instalment | 16,000 ÷ 12 = 1,333.33 | 1,128.25 (constant, French) |
The difference in interest: 2,460.93. Flat interest charges the client almost 70% more than interest on the balance (or, seen the other way round, interest on the balance is 41% cheaper) for the exact same "5% monthly", purely because of how it is calculated. If you advertise your rate as 5% monthly and use flat interest, your real effective rate is much higher than the 5% you stated, even though you never lied about a number.
Why flat interest looks cheaper and is not
Flat interest confuses people because the number that gets advertised ("5% monthly") is identical in both methods: what changes is what that 5% is applied to, not the number itself. It is the same trap we covered in How much interest to charge for lending money: the rate you say is not always the rate you charge. Here we take it to the opposite extreme: two methods, the same nominal rate, a very different final result.
For the lender, flat interest is not automatically "more profitable": it is more profitable IF the client does not compare it against another option, and IF your country's law does not require disclosing the effective rate (see Is it legal to lend money with interest?). For the client, flat interest almost always ends up more expensive at the same advertised number.
How each instalment splits, month by month
With interest on the balance (French method), the instalment is always the same (1,128.25), but the internal split changes: the first instalment carries 500 in interest and 628.25 in principal; the last one carries just 53.73 in interest and 1,074.52 in principal. The full breakdown and the rounding residue are covered in The amortisation table.
With flat interest, the instalment is always 1,333.33 and the interest "hidden" inside it is also always the same: exactly 500, month after month, no matter how much principal the client has already repaid. That is why flat interest does not produce a real amortisation table: there is no balance to amortise, because the calculation ignores the balance.
When each one makes sense
Situation | Recommended method |
|---|---|
Evaluated client, formal loan, term of several months | On the balance: costs less and is defensible against any claim |
Very short-term micro-loan (days or a few weeks) | Flat is usually fine: the gap between methods is small over short terms |
You want to compare your return against other investments | On the balance: the effective rate is the one you can truly compare |
The client asks "how much do I pay in total?" before signing | Either, as long as you tell them the total, not just the monthly rate |
The practical rule: the longer the term, the wider the gap between the two methods grows. On a loan of 2-3 instalments it barely matters which you use; on one of 12 or more, the difference is too large to ignore.
Try your own numbers
With your amount, your rate and your term, the difference could be bigger or smaller than in the example. Compare them in the Flat vs. balance interest calculator: enter the amount, the rate, the number of instalments and the frequency, and it shows you the instalment and the total interest cost for both methods, side by side.
Frequently asked questions
Is interest on the balance always cheaper for the client? At the same advertised nominal rate, yes, always: it is arithmetic, it does not depend on the case. What changes between loans is by how much: over short terms the difference is small, over long terms it can be enormous.
Can I charge flat interest as long as I disclose that it is flat? In most cases yes, as long as it is transparent and stays within your country's legal caps applied to the effective rate, not the nominal one. The legal and reputational problem is not using flat interest, it is advertising a rate that sounds lower than it really is.
How do I know what effective rate I am charging if I use flat interest? With the RATE function (or TASA) of any spreadsheet, using the instalment you actually charge and the amount lent. We walk through it step by step with worked examples in How much interest to charge for lending money.
Summary
- Flat interest: always calculated on the original amount. Easy to calculate, more expensive for the client.
- Interest on the balance: calculated on what is still owed. Fairer, and the standard French method.
- At the same "advertised" rate, the difference in total interest can top 40% over a one-year term.
- The longer the term, the wider the gap between the two methods grows.
- Try your own numbers in the calculator before you set your rate.
Prestafolio calculates the full schedule using the French method (interest on the balance) before you hand the money over, so you see the real instalment and the real total cost, not a rate that just sounds good: see Simulating a loan and Loan types.