There are generally two types of interest rates – **a flat interest rate** (not to be confused with a fixed interest rate) and a **reducing balance interest rate**.

**Flat interest rate**

A flat interest rate is **calculated based on the original amount you borrow** (or principal).

For example, if you take a 5-year loan for RM1,000 at a flat interest rate of 4% per annum, you will be paying an interest of RM40 (i.e. 4% of RM1,000) every year for 5 years. In total, **you will have paid RM200 in interest payments**.

As a result, **the total interest you need to pay remains the same no matter how much of the principal you repay**.

*Your EIR here is 7.42% (compared to the given flat interest rate of 4%).*

This interest rate method is used **for personal loans and vehicle/hire purchase loans**.

**Reducing balance interest rate**

A reducing balance interest rate, on the other hand, is **calculated based on your outstanding or leftover loan balance**, which is the amount you originally borrowed (the principal) minus the amount you’ve already paid off.

For example, you take a 5-year loan for RM1,000 at a reducing balance interest rate of 4% per annum and make monthly payments. You’ll be paying off a bit of your principal each month, so the amount of interest you pay will also go down. In total (after the 5 years), **you’ll have paid RM105 in interest payments**.

*Notice how this RM105 is about half of the RM200 interest for a flat interest rate loan of 4% per annum.*

*Your EIR here is 4% (same as the given reducing balance rate of 4%).*

This interest rate method is most commonly **used for home loans**.