Add-On Rate vs Diminishing Balance: What Your Loan Really Costs
Why a “1.5% a month” loan can cost more than a bank loan at 18% a year, how amortization works, and how to compare offers using the effective interest rate.
Updated
Two loans can quote rates that look similar and cost very different amounts. The difference is how the interest is computed.
Diminishing balance
Banks usually quote housing, car, and many personal loans as an annual rate on a diminishing balance. Each month, interest is charged only on what you still owe:
interest this month = remaining balance × (annual rate ÷ 12)
Your monthly amortization stays the same, but its mix changes. Early payments are mostly interest; later payments are mostly principal. The Loan Amortization Calculator shows this month by month.
Add-on (flat) rate
Many salary loans, appliance loans, and lending companies quote an add-on rate per month. Interest is charged on the original loan amount for the whole term:
total interest = loan amount × monthly rate × number of months
Because you keep paying interest on money you’ve already repaid, an add-on rate costs far more than the same number as a diminishing rate.
Same number, different cost
Borrow ₱100,000 for 12 months:
| Rate quoted | Total interest |
|---|---|
| 1.5% a month add-on | ₱18,000.00 |
| 18% a year, diminishing balance | about ₱10,015 |
The add-on loan’s effective rate is roughly 32% a year before fees.
Fees raise the real rate too
Processing fees, service charges, and documentary stamp tax are often deducted from your proceeds. You borrow ₱100,000, receive ₱98,000, and repay as if you got the full amount. That pushes the effective rate higher.
Compare with the effective interest rate
Bangko Sentral rules require banks and lenders to disclose the effective interest rate (EIR), the rate that accounts for both the computation method and fees. When comparing offers, compare EIRs, not quoted rates.
The Personal Loan Calculator works out the EIR for any add-on or diminishing-balance offer.
Tips before you sign
- Ask for the disclosure statement and find the EIR and total amount payable.
- Check for pre-termination fees and whether unearned interest is refunded if you pay early.
- Keep total loan payments to an amount you can cover even in a tight month; your take-home pay is the real budget, not your gross salary.