Flat vs reducing-balance interest: which should your group use?

Two loans can both say "12% a year" and cost very different amounts. The difference is whether interest is flat or on a reducing balance. Whichever your group uses, members should understand it.

#Flat interest

Interest is calculated on the original amount for the whole term:

Interest = principal × annual rate × (months ÷ 12)

It doesn't matter that the borrower is paying the loan down each month — interest is always based on the starting amount.

#Reducing-balance interest

Interest is calculated each month on what's still owed. As the balance falls, so does the interest. Banks and most regulated lenders use this method.

#Worked example: GHS 1,200 at 12% for 12 months

#Flat

• Interest = 1,200 × 12% × 1 = GHS 144
• Total repaid = GHS 1,344
• Monthly instalment = 1,344 ÷ 12 = GHS 112

#Reducing balance (1% a month)

• Monthly instalment ≈ GHS 106.62
• Total repaid ≈ GHS 1,279.43
• Interest ≈ GHS 79.43

A flat 12% costs roughly what a reducing-balance 21–22% would. That isn't a trick — it's arithmetic — but members should know it.

#Which should your group use?

Flat suits most informal groups: everyone can check the numbers, and schedules are simple. If you use it, consider:

• setting lower headline rates than a bank would quote;
• stating the approximate equivalent rate when you explain products;
• deciding what happens on early repayment — for example, charging interest only for the months used.

Reducing balance suits larger funds with software that can produce schedules, especially if members compare against bank loans.

#Whatever you choose

• Fix the method in your constitution and lending policy.
• Show every borrower the full schedule before they accept.
• Split each repayment correctly between principal and interest in the books — see how to run loans in a savings group.

#Early repayment: the question members always ask

Suppose Ama borrows GHS 1,200 at a flat 12% for 12 months and wants to repay everything after 6 months.

• Strict flat interest: the full GHS 144 interest is due, even though she only borrowed for half the term. Simple, but it feels unfair and discourages early repayment.
• Pro-rated flat interest: charge interest only for the months used — GHS 72 — plus whatever principal is still owed.
• Reducing balance: interest naturally stops accruing once the balance is repaid.

Whichever you choose, write it into your lending policy so the answer is the same for everyone.

#Explaining the rate to members

A one-line disclosure avoids misunderstandings:

"Personal loans cost 10% flat per year. On a 6-month GHS 1,000 loan that's GHS 50 in interest, repaid as 6 instalments of GHS 175."

Showing the real money amounts, not just a percentage, is the clearest way to be fair.

AwaFund uses flat interest fixed at approval, shows the member the whole schedule before they apply, and splits every repayment into principal, interest and penalties automatically. Try it free.

Frequently asked questions

Is flat interest unfair to borrowers?

Not if it's clearly explained. It's simpler to calculate and share, but the same headline rate costs more than reducing-balance interest, so groups using flat rates often set lower headline rates.

What rate should our group charge?

Enough to reward savers and cover occasional losses, but below what members would pay elsewhere. Many member funds sit well below commercial lenders. Agree it at a general meeting.

This guide is general information to help groups organise themselves. It isn't financial, tax or legal advice — rules for savings groups differ by country, so check with a qualified adviser for your situation.