The interest method tells you which balance the lender uses to calculate interest. It is as important as the percentage rate. Always compare loans using total repayment, fees and timing—not the headline rate alone.
Reducing-balance interest
Interest is charged on the principal still outstanding for each period. In a standard amortised loan, the installment is usually level while the interest portion falls and the principal portion rises. Some reducing-balance products instead use equal principal payments, so the total installment reduces over time. Ask which schedule applies.
Flat-rate interest
Interest is calculated from the original principal for the stated term, even as installments reduce the amount you owe. A simple annual flat-rate calculation is principal multiplied by annual rate multiplied by years. The principal plus that interest is then divided across installments.
| Question | Reducing balance / amortised | Flat rate |
|---|---|---|
| Interest base | Outstanding principal | Original principal |
| Interest through time | Falls as balance falls | Allocated from a total computed on original principal |
| Typical equal-payment result | Interest falls; principal rises | Principal and interest portions often remain level |
| Best comparison | Total repayment plus fees | Total repayment plus fees |
Why identical rates are not identical costs
A 12% flat rate and a 12% annual reducing-balance rate are not economically equivalent because the interest base differs. Converting between them depends on term, frequency, fees and cash-flow timing. The responsible comparison is the actual payment schedule and total cost.
Worked example: KES 300,000 over 24 months
Assume monthly repayments, a stated annual rate of 12% and no fees or insurance.
For a simple flat-rate loan:
- Interest is KES 300,000 × 12% × 2 years = KES 72,000.
- Total repayment is KES 372,000.
- Dividing by 24 gives an installment of KES 15,500.
For a standard amortised reducing-balance loan, the monthly rate is 1% and the estimated equal installment is about KES 14,122. Total scheduled repayment is about KES 338,929, of which about KES 38,929 is interest. Small differences can arise from rounding and the final-payment adjustment.
| Same headline rate and term | Reducing balance | Flat rate |
|---|---|---|
| Principal | KES 300,000 | KES 300,000 |
| Approximate monthly payment | KES 14,122 | KES 15,500 |
| Approximate total interest | KES 38,929 | KES 72,000 |
| Fees included? | No | No |
This example does not prove that every reducing-balance offer is cheaper. A different rate, financed fee, payment frequency or term can reverse a comparison. It shows why the calculation method must be known.
Check the rate period before calculating
“One percent” might mean 1% per month, while “12 percent” might mean 12% per year. Those statements may describe a similar nominal rate, but the payment schedule and effective cost still depend on how the lender applies and compounds the rate. Never assume a percentage is annual unless the document says so.
For weekly, fortnightly or quarterly payments, the periodic rate and number of payments must use matching periods. Dividing an annual rate by 12 while using weekly payments produces the wrong result.
Flat rate is not the same as fixed rate
“Flat” describes the balance used to calculate interest. “Fixed” describes whether the rate can change. A reducing-balance loan can have a fixed rate, and a product document should distinguish those ideas. Ask whether the percentage can change during the term and what notice or formula applies.
Fees can hide the real comparison
Compare the amount you actually receive with everything you must repay. If KES 10,000 is deducted from a KES 300,000 approval for fees or insurance, receiving KES 290,000 while repaying a schedule based on KES 300,000 changes the economic cost. Add application, appraisal, insurance, legal, account and settlement charges where they apply.
Regulated SACCO lending disclosures should state the amount financed, finance charges, interest-computation method, refinancing conditions, statement frequency and collateral. Request the written disclosure and schedule rather than reconstructing an offer from an advertisement.
Questions to ask the lender
- Is the rate annual, monthly or for the full term?
- Is interest flat, reducing, fixed or variable?
- Are installments equal, or is equal principal used?
- What amount will reach my account after deductions?
- What is the total scheduled repayment including disclosed fees?
- Can I repay early, and how will the settlement be calculated?
- Which amount attracts a late charge if a payment is missed?
Print both schedules and compare the first payment, last payment, total interest, total repayment and outstanding balance after the same number of installments. Then compare those estimates with the lender's official documents.
Primary sources
These links support the important legal or regulatory points in this guide. Verify that you are reading the current version.