How is business loan interest calculated?

2 min read

Reducing balanceOn what you owe

Flat rateOn the original sum

Total repayableCompare on this

The two main methods

On a reducing-balance loan, interest is charged only on the outstanding balance, so each payment covers a shrinking amount of interest and a growing amount of capital. On a flat rate, interest is charged on the full original amount for the whole term.

A quick example

Borrow £20,000 over two years. On a 10% reducing-balance basis you pay around £2,150 in interest; on a 10% flat rate you pay £4,000 — nearly double — because the 10% applies to the whole £20,000 both years. Same headline rate, very different cost.

What it means for you

Always check which method a lender uses and compare on total repayable.

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Read how loan interest is calculated and use the repayment calculator.

Frequently asked questions

Does repaying early save interest?

On a reducing-balance loan, usually yes, because interest is charged on the outstanding balance. On a flat rate the saving may be smaller. Check for any early-settlement charge first.

Which method is more common?

Reducing balance is standard for most business term loans and is the fairer basis. Flat rates and factor rates appear on some short-term and turnover-linked products.