Flat Rate vs Reducing Balance Loans in Kenya

The two ways interest is charged

A flat rate charges interest on the full original principal for the entire term, even though you are steadily repaying the balance. A reducing balance rate charges interest only on the amount still outstanding, so interest falls as you repay.

• Flat rate: interest is fixed on the original amount for the whole term. Common in some SACCO and asset finance products.
• Reducing balance: interest is charged on the outstanding balance each month. Common in bank personal loans and mortgages.

Worked example: same 12% rate, different cost

Both loans below are KSh 100,000 repaid over 24 months and both quote 12% a year. Only the method of charging interest differs.

Good to know: At the same quoted rate, the flat-rate loan costs about KSh 11,000 more over two years — about 1.85 times the interest of the reducing balance loan.

Why flat rates look cheaper than they are

Because the quoted flat rate ignores the fact that you are repaying the principal, its effective cost is close to double the stated figure. A lender quoting a flat rate may appear cheaper than one quoting a similar reducing balance rate, when the opposite is true.

When you compare offers, ask directly how interest is calculated and compare the total amount repayable, not just the advertised rate.

Fees that add to the cost of credit

• Processing or arrangement fees, often a percentage of the loan.
• Credit life or asset insurance bundled into the loan.
• Monthly ledger or service fees on some facilities.
• Early settlement penalties, which can wipe out the benefit of repaying early.

What to compare before signing

• Total Cost of Credit (TCC), not just the interest rate.
• Monthly repayment and how it fits your budget.
• Whether the rate is flat or reducing balance.
• The effect of any compulsory insurance or fees.
• What happens if you repay early or miss a payment.