Flat rate vs reducing balance: why an 8% car loan costs 15%

A dealer offers you 500,000 of car finance at 'just 8% for five years'. Another lender quotes 13% reducing balance. The first sounds obviously cheaper. It is not — it is slightly worse.

On the flat-rate deal, interest is calculated once on the full 500,000: 500,000 × 0.08 × 5 = 200,000. You repay 700,000 in 60 instalments of 11,667. Critically, that interest never shrinks even though your balance does. By month 50 you owe about 83,000 but you are still being charged interest as though you owed the whole half million.

On a reducing-balance loan, interest is recomputed each month on what is actually outstanding. At 13% over five years, the payment is roughly 11,377 and total interest lands near 182,600 — less money, on a rate five points higher.

The rough conversion is useful to memorise: a flat rate is close to 1.8x the equivalent reducing-balance rate for a mid-length loan. An 8% flat quote is really about 14.5%. A 6% flat quote is really about 11%.

How to protect yourself: ask for the total amount repayable, not the rate. Total repayable is definitionally comparable across quoting conventions. If a salesperson will not give you that number in writing, you have learned something more useful than the rate anyway.

Then run both structures — simple interest for the flat quote, the loan calculator for the reducing-balance quote — and compare lifetime cost. The deal with the lower total wins, regardless of which one had the prettier percentage on the poster.