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How to Calculate Loan Interest Using Straight Line and Reducing Balance

01 Apr, 2026

Introduction

In microfinance and banking management, calculating loan interest accurately is essential for transparency, compliance, and member trust. Two common methods are used to compute loan interest: the Straight Line Method and the Reducing Balance Method.

This guide explains both methods step by step, with formulas and examples, so you can apply them in your institution's loan management processes.

Prerequisites

Before you start:

Straight Line Method

The Straight Line Method (also called flat-rate interest) calculates interest on the original loan amount throughout the loan period.

Formula

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Interest = Principal × Rate × Time

Example

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Interest = 10,000 × 0.12 × 2 = 2,400
Total repayment   = Principal + Interest = $12,400 
Monthly repayment = $12,400 ÷ 24 = $516.67

Amortization Table for Straight Line Method:

Here is how the armotization table for the straight line method looks like.

Month Principal ($) Interest ($) Total Payment ($)
1 416.67 100.00 516.67
2 416.67 100.00 516.67
3 416.67 100.00 516.67
4 416.67 100.00 516.67
5 416.67 100.00 516.67
6 416.67 100.00 516.67
7 416.67 100.00 516.67
8 416.67 100.00 516.67
9 416.67 100.00 516.67
10 416.67 100.00 516.67
11 416.67 100.00 516.67
12 416.67 100.00 516.67
13 416.67 100.00 516.67
14 416.67 100.00 516.67
15 416.67 100.00 516.67
16 416.67 100.00 516.67
17 416.67 100.00 516.67
18 416.67 100.00 516.67
19 416.67 100.00 516.67
20 416.67 100.00 516.67
21 416.67 100.00 516.67
22 416.67 100.00 516.67
23 416.67 100.00 516.67
24 416.09 100.00 516.09
------- --------------- -------------- -------------------
Total 10,000.00 2,400.00 12,400.00

The last month should absorb the rounding difference so the totals reconcile exactly.

Reducing Balance Method

The Reducing Balance Method calculates interest on the outstanding loan balance after each repayment. This means interest decreases as the loan balance reduces.

Formula

text
Interest (per period) = Outstanding Balance × Rate

Example

text
EMI = [P × r × (1 + r)^n] ÷ [(1 + r)^n – 1]

Where:

text
EMI = [10,000 × 0.01 × (1.01)^24] ÷ [(1.01)^24 – 1]
EMI ≈ 470.73
Monthly repayment = $470.73
Total repayment   = $470.73 × 24 = $11,297.52

Notice that this is lower than the Straight Line Method, because interest reduces as the balance decreases.

Amortization Table for Reducing Balance Method:

Here is how the armotization table for the reducing balance method looks like.

Month Principal ($) Interest ($) Total Payment ($)
1 370.73 100.00 470.73
2 374.44 96.29 470.73
3 378.18 92.55 470.73
4 381.96 88.77 470.73
5 385.78 84.95 470.73
6 389.64 81.09 470.73
7 393.53 77.20 470.73
8 397.47 73.26 470.73
9 401.44 69.29 470.73
10 405.46 65.27 470.73
11 409.51 61.22 470.73
12 413.61 57.12 470.73
13 417.74 52.99 470.73
14 421.92 48.81 470.73
15 426.14 44.59 470.73
16 430.40 40.33 470.73
17 434.70 36.03 470.73
18 439.05 31.68 470.73
19 443.44 27.29 470.73
20 447.87 22.86 470.73
21 452.35 18.38 470.73
22 456.87 13.86 470.73
23 461.44 9.29 470.73
24 466.33 4.40 470.73
------- --------------- -------------- -------------------
Total 10,000.00 1,297.52 11,297.52

The last month should absorb the rounding difference so the totals reconcile exactly.

Comparison

Method Interest Basis Total Repayment Monthly Repayment
Straight Line Original Principal $12,400 $516.67
Reducing Balance Outstanding Balance $11,297.52 $470.73

Conclusion

In this guide, you learned how to calculate loan interest using the Straight Line Method and the Reducing Balance Method.

Choosing the right method depends on your institution's policies and the type of loan product offered.