Flat rate vs reducing balance loans: what you really pay
Updated 15 October 2026 · 6 min read
Two lenders can both quote you "14%" and still charge very different amounts. The difference is what the interest is charged on. This guide works through the same loan both ways so you can see the gap in shillings.
The two methods
- Reducing balance: interest is charged only on what you still owe. As you repay, the interest shrinks. Banks in Kenya quote loans this way.
- Flat rate: interest is charged on the original amount for the whole term, even after you've repaid most of it. Some SACCOs, chamas, shops and lenders use it because it's easy to work out.
If you use Excel, reducing balance is the PMT function. Flat rate is just amount × rate × years, spread evenly over the months.
Worked example: KSh 200,000 over 12 months at 14%
Flat rate. Interest = KSh 200,000 × 14% × 1 year = KSh 28,000. You repay KSh 228,000 in 12 payments of KSh 19,000. Every month, KSh 2,333 of that is interest, the same in month 12 as in month 1, even though by then you owe very little.
Reducing balance. The monthly rate is 14% ÷ 12 = 1.1667%. The standard loan formula (Excel: =PMT(14%/12, 12, -200000)) gives a monthly payment of KSh 17,957.
| Month | Interest | Principal | Balance after |
| 1 | KSh 2,333 | KSh 15,624 | KSh 184,376 |
| 12 | KSh 207 | KSh 17,750 | KSh 0 |
Interest falls every month because the balance falls. Over the year you repay KSh 215,489, so total interest is KSh 15,489.
| Flat rate | Reducing balance | |
| Monthly payment | KSh 19,000 | KSh 17,957 |
| Total repaid | KSh 228,000 | KSh 215,489 |
| Total interest | KSh 28,000 | KSh 15,489 |
Same amount, same term, same "14%". The flat-rate loan costs KSh 12,511 more: 81% more interest.
The rule of thumb: a flat rate is close to double
On average you only owe about half the loan over its life, but a flat rate charges you as if you owed all of it the whole time. So a flat rate works out at close to double the equivalent reducing balance rate.
In our example, KSh 19,000 a month for 12 months on KSh 200,000 is the same as a reducing balance rate of about 24.9%, not 14%. Over 36 months, a 14% flat rate is about 24.4% reducing. Either way, think "nearly double" whenever you hear "flat".
Fees: the cost that hides outside the rate
The interest rate is only part of the price. Ask about:
- Processing or arrangement fee: often a percentage of the loan, sometimes taken off before you get the money.
- Insurance: credit life cover, so the loan is paid off if you die. Sometimes charged upfront for the whole term.
- Excise duty on fees: a 20% tax that some lenders, especially digital lenders, add on top of their fees. Ask whether it applies.
- Legal, valuation and other fees: common on loans secured by land, a car or a logbook.
- Late payment and early repayment penalties.
What fees do to our example. Say the reducing balance loan has a 2% processing fee (KSh 4,000), 20% excise duty on that fee (KSh 800) and 1% insurance (KSh 2,000), all deducted upfront. These are example figures, not any lender's actual charges. You receive KSh 193,200 but still repay KSh 17,957 a month, so the real yearly cost rises from 14% to about 20.7%.
APR and total cost of credit
That all-in figure is the annual percentage rate (APR): interest and fees folded into one yearly rate. The total cost of credit is the same idea in shillings: everything you pay on top of what you borrow. The Kenya Bankers Association and the Central Bank of Kenya run a cost-of-credit website (costofcredit.co.ke) where you can compare bank loans by APR.
Compare loans on APR or total cost of credit, never on the quoted rate alone. Put each offer and its fees into the loan calculator and compare the "Total you repay" line.
What to ask before you sign
- Is the rate flat or reducing balance?
- Is the rate per month or per year? 1.5% a month is 18% a year.
- What is the APR, and the total cost of credit in shillings?
- What fees are charged, and are they deducted from the loan?
- Is there a penalty for paying early? With reducing balance, paying early saves interest.
- Can the rate change during the loan?
- Can I have the repayment schedule in writing?
Then check the lender is licensed. Banks and digital lenders are licensed by the Central Bank of Kenya, which publishes a list of approved digital credit providers. Deposit-taking SACCOs are licensed by SASRA.
Frequently asked questions
Which is better, flat rate or reducing balance?
Reducing balance is cheaper for the borrower at the same quoted rate, because you only pay interest on what you still owe. A 14% flat-rate loan costs about the same as a 24% to 25% reducing balance loan.
How do I convert a flat rate to a reducing balance rate?
Work out the monthly payment on the flat-rate loan, then find the reducing balance rate that gives the same payment. In Excel, =RATE(months, -payment, amount)*12 does this. As a quick check, the answer is close to double the flat rate.
How is loan interest calculated in Kenya?
Most banks charge interest on a reducing balance, while some SACCOs, chamas and lenders use a flat rate. Always ask which one, and whether the rate is monthly or yearly.
Why is my loan more expensive than the interest rate suggests?
Fees, insurance and excise duty add to the cost, especially when they're taken off the loan upfront. The APR includes them, which is why it's the better number to compare.
For education only, not financial advice. Your lender's figures may differ slightly because of rounding, payment dates and fees.