Compare two loan offers side by side to see which costs less overall.
Both loans are run through the same amortization formula, so you can compare monthly payment and total interest cost side by side, even if the amount, rate or term differ.
The headline interest rate is only one input into what a loan actually costs — processing fees (commonly 0.5-2% of the loan amount, charged upfront), prepayment or foreclosure penalties, and whether interest is calculated on a reducing balance versus a flat rate all change the real comparison. A loan advertising a slightly lower rate but a higher processing fee and a stiff prepayment penalty can easily cost more over a typical holding period than a loan with a marginally higher rate but no such charges — especially for anyone who expects to repay early, which is common once income rises or a bonus arrives.
Flat-rate versus reducing-balance interest is the single most consequential — and most commonly misunderstood — difference between two loan offers. A flat rate calculates interest on the original principal for the entire tenure, even as the balance is paid down, while a reducing-balance rate calculates interest only on what is still outstanding, which is why a "12% flat rate" loan can cost roughly the same as a reducing-balance loan advertised at 20-22% — the two numbers are not directly comparable without converting one to match the other's basis first.
Because the advertised rate ignores processing fees, prepayment penalties, and whether the rate is flat or reducing-balance — a lower rate with a high processing fee and a stiff foreclosure penalty can cost more in total than a marginally higher rate with none of those charges, particularly if you plan to prepay early.
A flat rate charges interest on the full original loan amount for the entire tenure, regardless of how much principal has already been repaid. A reducing balance rate charges interest only on the outstanding balance, which shrinks with every payment — this difference alone means a "12% flat" loan can cost roughly as much as a "20-22% reducing balance" loan, so the two figures are not directly comparable.
Commonly 0.5-2% of the loan amount, charged upfront rather than spread across the tenure — on a large loan this can be a meaningful sum, and it should be added to the total cost comparison rather than ignored just because it is a one-time charge.
It usually means less total interest paid for the same loan amount and rate, since interest has less time to accrue — but it also means a higher EMI, so the right tenure is a balance between minimizing total cost and keeping the monthly payment genuinely affordable, not simply the shortest option available.