Reducing Balance Method
An interest calculation where interest is charged each period on the loan's outstanding balance, so the interest component falls as the principal is repaid. Standard for home, car and most modern retail loans in India.
Mathematical Formula
Context & Practical Application
What is the Reducing Balance Method? (Simple Terms)
Under the reducing balance method, interest is charged each month only on the money you still owe. As every EMI repays a little principal, the balance falls, and the interest charged on it falls too.
A ₹8 Lakh car loan at a quoted 9.5% costs about ₹2.08 Lakh in interest on this method.
Understanding the Reducing Balance Method
Almost every home, car and personal loan in India is priced this way. The quoted rate applies to the shrinking balance, which is why repaying earlier saves money: every rupee of principal repaid stops earning interest for the lender.
Contrast it with flat rate interest, charged on the full original amount for the whole tenure. The same ₹8 Lakh car loan costs ₹3.80 Lakh flat versus ₹2.08 Lakh on reducing balance, about ₹1.72 Lakh more. Your EMI and the amortization schedule follow from this method; see What is EMI?.
Mathematical Analysis of the Reducing Balance Method
For instalment , with monthly rate equal to the annual rate divided by 12:
The balance evolves as , so total interest is the sum of every term, path-dependent on rate, tenure and prepayment timing, not on the original amount alone. At no interest accrues.
Referenced In Guides & Comparisons
Learn how Reducing Balance Method is applied in real-world scenarios across our pathways: