Flat Rate or Effective Rate: Why the Same Number Means Two Prices
Summary
A flat rate charges interest on the full original amount for the entire tenure, while an effective rate charges only what you still owe, so the same printed number means roughly double the price. On RM20,000 over five years, 6 per cent flat costs RM6,000 in interest against about RM3,200 on a 6 per cent reducing balance loan. From 1 January 2027 the flat rate is prohibited for personal financing in Malaysia.
The rate basis matters more than the rate. Two offers can print the same percentage and cost you very different amounts, because they measure interest against different things. Getting this one distinction right is usually worth more than shopping for a slightly lower headline number.
What a flat rate charges
A flat rate is applied to the original amount borrowed, every year, for the whole tenure, regardless of how much you have already repaid. Borrow RM20,000 at 6 per cent flat over five years and the interest is RM20,000 times 6 per cent times 5, which is RM6,000. Total repayment is RM26,000, or about RM433 a month.
The oddity is that in month 59, when you owe only a few hundred ringgit, you are still being charged interest as though you owed the full RM20,000.
What an effective rate charges
An effective rate, also called reducing balance, is applied only to the outstanding balance. As the balance falls, the interest portion of each instalment falls with it. The same RM20,000 over five years at 6 per cent on a reducing balance costs roughly RM3,200 in interest, with an instalment near RM387.
Same amount, same tenure, same printed number. The flat version costs about RM2,800 more.
The rough conversion
For a loan repaid in equal monthly instalments, a flat rate works out to somewhere near 1.8 to 2 times the equivalent effective rate. So 6 per cent flat behaves like roughly 11 per cent effective, and 8 per cent flat like roughly 15 per cent. Treat that as a sanity check rather than a precise formula; it is enough to tell you when two offers are not comparable.
How to tell which one you are being quoted
- Ask directly whether the rate is flat or on a reducing balance, and ask for the answer in writing.
- Ask for the effective interest rate. A lender quoting a flat rate can still tell you the effective equivalent.
- Do the arithmetic yourself: multiply the instalment by the number of instalments, then subtract the amount you actually received. That difference is the true cost of the loan, whatever the rate is called.
What changes on 1 January 2027
Bank Negara Malaysia issued its Policy Document on Personal Financing on 30 September 2025. Most of it took effect on issuance, but a set of paragraphs was deferred, and those deferred paragraphs prohibit financial service providers from computing interest or profit on personal financing using a flat rate or the Rule of 78, with effect from 1 January 2027.
Two practical consequences follow. Until that date, a flat rate offer is still lawful, so the comparison above still matters. And if you are choosing between borrowing now and waiting, the pricing basis is one more thing to weigh, alongside whether you need the money at all right now.
In short
Never compare two loans on their printed percentage alone. Convert both to the same basis, or compare total repayment against cash received. That single habit is worth more than any negotiation.
