Flat Rate vs. Reducing Balance: How Nigerian Banks Hide the Real Cost

When you apply for a loan in Nigeria—whether from a traditional bank or a microfinance bank (MfB)—you will often see two types of interest rates quoted: Flat Rate and Reducing Balance Rate.

Understanding the difference is crucial. Many loan apps use Flat Rates to make their loans look cheap, when they are actually very expensive.

What is Flat Rate Interest?

Flat Rate interest is calculated on the original principal amount for the entire duration of the loan. It does not decrease as you pay back the loan.

Example:

• Loan Amount: ₦1,000,000
• Interest Rate: 10% per year (Flat)
• Term: 1 Year

Calculation:

• Interest per year = 1,000,000 × 10% = ₦100,000
• Total Interest for 1 year = ₦100,000
• Monthly Payment = (1,000,000 + 100,000) / 12 = ₦91,667

Even in the last month, when you owe almost nothing, you are still paying interest based on the full 1 million naira.

What is Reducing Balance Interest?

Reducing Balance (standard for most mortgages and transparent loans) is calculated on the outstanding balance at the end of each month. As you pay off the loan, the interest amount drops.

Example:

• Loan Amount: ₦1,000,000
• Interest Rate: 10% per year (Reducing)
• Term: 1 Year

Calculation:

• Month 1 Interest: 1,000,000 × (10%/12) ≈ ₦8,333
• Month 1 Payment: ₦87,916 (Standard EMI)
• Principal Paid in Month 1: 87,916 - 8,333 = 79,583
• New Balance: 1,000,000 - 79,583 = 920,417
• Month 2 Interest: 920,417 × (10%/12) ≈ ₦7,670 (Lower!)

Total Interest Paid: ≈ ₦54,991 (Compared to ₦100,000 with Flat Rate!)

The "Trap" of Flat Rates

Lenders often advertise Flat Rates because the percentage number looks lower.

• A 10% Flat Rate is roughly equivalent to a 17-19% Reducing Balance Rate.
• If Bank A offers "10% Flat" and Bank B offers "15% Reducing", Bank B is actually cheaper, even though 15% sounds higher than 10%.

How to Compare?

Always ask the loan officer for the Effective Interest Rate (EIR). If they can't tell you, use our calculator.

Our Loan Calculator does this for you automatically! Simply select "Flat Rate" as the interest type, and we will show you the true cost.

Key Takeaway

Never accept a loan based on the "Flat Rate" number alone. Always ask: "Is this flat or reducing?" and calculate the total Naira you will pay back.