Flat rate versus reducing balance
A flat rate is charged on the original amount for every year of the loan. A reducing-balance loan charges interest on what is still owed, which falls as you repay. That is why a 6% flat rate costs roughly as much as an 11% reducing-balance loan.
Dealers and some lenders quote flat rates because the number looks lower. Always compare the APR, which puts both methods on the same footing.
Worked example
Borrowing £18,000 at a 6% flat rate over 5 years costs £1,080 a year in interest, or £5,400 over the term. The total repayable is £23,400, which is £390 a month.
The equivalent APR is 11.40%. A reducing-balance loan at 6% would cost far less, so the two quotes are not comparable until you look at the APR.
Questions to ask a dealer
Ask whether the quoted rate is flat or reducing, and what the APR is. The APR includes the effect of fees, so it is the number to compare between offers.
If a settlement figure is quoted, ask whether the rebate is calculated on the flat interest or on a reducing balance. Early settlement on flat-rate finance can be less generous than you expect.
Inputs for the simple car loan calculator
Amount borrowed
The amount financed after any deposit.
Flat interest rate (per year)
The yearly rate charged on the full amount for the whole term.
Term
How long the loan runs, in years.
CALCULATOR QUESTIONS
Car loan calculator simple questions
Is a flat rate the same as an APR?
No. A flat rate is charged on the original amount; the APR reflects the reducing balance and any fees. A 6% flat rate is about an 11.4% APR over five years.
Why is the APR so much higher?
Because you repay part of the principal every month, so you do not have the full amount for the whole term. The flat calculation ignores that.
Can I settle a flat-rate loan early?
Usually yes, but the rebate may be calculated on the flat interest, which can make early settlement less rewarding.
Which is cheaper, flat or reducing?
At the same headline rate, reducing balance is much cheaper. Compare APRs to see the real difference.