Flat Rate vs Reducing Balance in Malaysia: How to Compare Using EIR (2026)

A flat rate charges interest on the original loan amount for the whole tenure, while a reducing balance rate charges interest only on what you still owe, so a 6% flat rate costs almost as much as an 11% reducing balance rate. To compare two offers fairly, convert the flat rate into its effective interest rate (EIR) and compare the EIR, the monthly instalment and the total repayment.

This matters more now. Since 1 June 2026, new hire purchase (car) financing in Malaysia is moving to EIR and the reducing balance method, and from 1 January 2027 banks can no longer offer personal financing priced on a flat rate or the Rule of 78.

Quick answer

• Flat rate: total interest = loan × flat rate × years. It never drops, even as you pay the loan down.
• Reducing balance: each month's interest = outstanding balance × (annual rate ÷ 12). Interest shrinks as the balance shrinks.
• The trap: the flat rate looks about half as big as the real cost. A 3% flat car loan over 9 years is roughly 5.5% EIR.
• The fix: always ask "What's the EIR?" and compare total repayment, not the headline rate.

How each method is calculated

Flat rate formula

1. Total interest = Loan amount × Flat rate × Tenure in years
2. Monthly instalment = (Loan amount + Total interest) ÷ Number of months

BNM's Personal Financing policy defines a flat rate as interest calculated on the original amount disbursed at the start of the loan, at a rate that stays the same for the whole tenure.

Reducing balance formula

The monthly instalment is fixed, but its split changes every month:

1. Interest this month = Outstanding balance × (Annual rate ÷ 12)
2. Principal paid = Instalment − Interest this month
3. New balance = Old balance − Principal paid

The instalment itself comes from the standard annuity formula: M = P × r ÷ (1 − (1 + r)^−n), where P is the loan, r is the annual rate ÷ 12, and n is the number of months. This is how housing loans, most new personal financing and (from 2026) new car loans work.

Worked example 1: RM30,000 personal loan, 5 years

Same loan, same "6%", two methods:

• 6% flat: total interest RM30,000 × 6% × 5 = RM9,000. Instalment (RM30,000 + RM9,000) ÷ 60 = RM650.00 a month.
• 6% reducing balance: instalment RM579.98 a month, total interest RM4,799.04.

The flat-rate loan costs RM70.02 more every month and RM4,200.96 more over five years. Its true EIR is about 10.85%, not 6%.

A common shortcut to convert flat to EIR is 2n ÷ (n + 1) × flat rate, where n is the number of months. Here that gives about 11.8%. It's a quick upper estimate and runs a bit high; the exact figure (the rate that produces the same RM650 instalment on a reducing balance) is 10.85%. You can test both methods side by side in the personal loan calculator.

Worked example 2: RM100,000 car loan, 9 years (BNM's own example)

Bank Negara's consumer guide to the Hire-Purchase (Amendment) Act 2026 uses this comparison:

• Bank A, 3% flat: RM1,175.93 a month, total interest RM27,000
• Bank B, 5.5% EIR: RM1,175.93 a month, total interest RM27,000
• Bank C, 5% EIR: RM1,151.76 a month, total interest RM24,390

Bank A and Bank B are the same deal written two different ways. Over 9 years, a 3% flat rate is equivalent to an EIR of about 5.5%. Bank C is the only cheaper offer, even though "5%" looks higher than "3%". (Our own calculation gives 5.498% for Bank A's EIR, and RM1,176.00 / RM1,151.73 for the instalments; BNM's figures are rounded slightly differently.)

Flat rate to EIR: quick conversion table

These exact conversions show how big the gap is. The longer the tenure, the more the EIR stays close to double the flat rate:

• 3% flat: 3 years ≈ 5.68% EIR · 5 years ≈ 5.64% · 7 years ≈ 5.57% · 9 years ≈ 5.50%
• 4% flat: 3 years ≈ 7.51% · 5 years ≈ 7.42% · 7 years ≈ 7.30% · 9 years ≈ 7.17%
• 6% flat: 3 years ≈ 11.08% · 5 years ≈ 10.85% · 7 years ≈ 10.58% · 9 years ≈ 10.33%
• 8% flat: 3 years ≈ 14.55% · 5 years ≈ 14.13% · 7 years ≈ 13.69% · 9 years ≈ 13.30%

Each EIR is the reducing-balance rate (annual rate ÷ 12, monthly instalments) that gives exactly the same instalment as the flat rate.

Why early settlement is cheaper on reducing balance

Old fixed-rate hire purchase and many older personal loans use the Rule of 78 to decide how much of each instalment is interest. It front-loads interest: you pay most of it in the early years, so your balance falls slowly at first.

On the BNM RM100,000 / 9-year example, the first 12 instalments (about RM14,111) split like this:

• Rule of 78 at 3% flat: RM5,642.20 interest, only RM8,468.96 off the loan
• Reducing balance at 5.5% EIR: RM5,279.55 interest, RM8,832.44 off the loan

Same instalment, but on reducing balance about RM363 more goes to the loan in year one, and the gap peaks at about RM632 by the end of year 3. If you sell the car or settle early, you owe less. BNM says this is the main reason the reducing balance method is replacing the Rule of 78 for fixed-rate hire purchase.

What's changing in Malaysia (2026–2027)

Hire purchase (car loans)

• The Hire-Purchase (Amendment) Act 2026 took effect on 1 June 2026. Fixed-rate hire purchase moves to EIR pricing and the reducing balance method.
• Providers have a grace period until 31 March 2027 to upgrade their systems, so some lenders may still quote flat rates until then. Ask whether they have switched.
• Rate caps: fixed-rate EIR is capped at 17% p.a. for tenures up to 5 years and 16% p.a. for tenures over 5 years. Variable-rate hire purchase stays capped at 17% EIR and already uses the reducing balance method.

Personal financing from banks

• From 1 January 2027, BNM's Personal Financing policy (paragraph 10.11) prohibits banks, Islamic banks and prescribed development financial institutions from offering personal financing where interest or profit is computed using a flat rate and/or the Rule of 78.
• They can still offer fixed or floating rates, as long as interest is charged on the outstanding principal.
• Before you sign, the lender must tell you the effective rate and total repayment amount (including in ads that mention a rate), and whether interest is calculated on a daily or monthly rest.
• This policy doesn't cover licensed moneylenders under the Moneylenders Act 1951, so check those offers extra carefully.

Housing loans

Housing loans already use the reducing balance method. Differences between banks usually come from the rate (SBR + spread), daily vs monthly rest and add-ons like MRTA. See why your bank's repayment differs from a calculator.

Common mistakes

• Comparing a flat rate with an EIR directly. "3% vs 5%" means nothing until both are EIRs.
• Using the flat rate to judge early settlement savings. On a Rule of 78 loan you save less than you'd expect when you settle early.
• Assuming every car loan is still flat rate. From June 2026, new hire purchase is moving to EIR. Ask which method your agreement uses.
• Ignoring fees. Processing fees, stamp duty and insurance raise the real cost on both methods. Compare total repayment plus fees.
• Focusing only on the instalment. A longer tenure lowers the instalment but raises total interest on both methods.

How to compare two offers in 4 steps

1. Ask each lender for the EIR, the monthly instalment and the total repayment amount.
2. Make sure the loan amount and tenure are the same in both quotes.
3. Add up all fees and any compulsory insurance.
4. Pick the lowest total cost you can comfortably afford every month.

For a full checklist, read how to compare personal loan rates in Malaysia. For the instalment maths step by step, see how personal loan monthly repayment works.

*KiraBoss guides are for general information only and are not financial advice. Check the product disclosure sheet and agreement from your lender.*