A lender offers you $10,000 for two years at “6% flat”. It sounds like a 6% loan. It is not, and the gap is one of the most common ways a borrowing decision goes wrong.
What “flat” means
A flat rate charges interest on the original amount for the whole term. On $10,000 at 6% for two years, that is $600 a year, or $1,200 in total. Add it to the amount borrowed and split it into 24 equal payments:
($10,000 + $1,200) ÷ 24 = $466.67 a month
What actually happens to the balance
Every payment you make repays part of the loan. After the first year you owe roughly half of what you started with. But a flat rate keeps charging as though you still owed all $10,000. You are paying interest on money you have already given back.
The rate you would compare against a bank loan
Bank loans, credit cards and mortgages are usually quoted on a reducing balance: interest is charged only on what you still owe. To compare fairly, ask what reducing-balance rate gives the same payment on the same loan. For this loan the answer is about 11.1% a year, nearly twice the headline number.
| Flat | Reducing balance | |
|---|---|---|
| Quoted rate | 6% | about 11.1% |
| Monthly payment | $466.67 | $466.67 |
| Total interest | $1,200 | $1,200 |
Same loan, same cost, two very different-sounding numbers. Only one of them lets you compare it with other offers.
The habit that protects you
When you hear a rate, ask what kind it is. Then ask for the total amount you will pay back, and any fees on top. If the lender will not give you the total, that tells you something too.
You can try your own numbers in the rate translator. It converts a flat rate to its reducing-balance equivalent for any amount and term. It is one of the central warnings in Chapter 11 of the book, where the full reasoning and the questions to ask are set out.
Illustrative example. Real offers vary in fees, timing and rules; this is general education, not personal advice.
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Try it with your own numbers
Rate translator
Want the checklists that go with this? Checklists, questions and worksheets inspired by the book, for the next time money is on the table. Part of the Reader’s Letter: a few times a year, never more.
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More notes
Five questions to ask before any money decision
Time, Cost, Risk, Incentives, Alternatives: five plain questions that work on a loan, an insurance policy, an investment or a pension, whatever the pitch.
The quiet tax: what $1,000 buys in 20 years
Inflation never sends a bill, but it takes purchasing power every year. At 3% it removes almost half of what a sum of money can buy over 20 years.
A 1% fee sounds small. Over 30 years it isn't.
Investment fees compound just like returns do. One extra percentage point on a 30-year plan can cost a fifth of the final pot.
General information and education only, not personal financial, tax, legal or investment advice. Figures are illustrative and use simplified assumptions.