Add-on Rate vs Diminishing Balance: Why the Same “Rate” Can Cost Almost Twice as Much

The two methods, in plain terms

Diminishing balance (also called reducing balance or amortizing) charges interest only on whatever principal you still owe. Pay down the balance, and next month's interest is computed on a smaller number — the interest portion of your fixed monthly payment shrinks over time while the principal portion grows. This is how Philippine banks quote personal, salary, and housing loans.

Add-on rate (also called flat rate) computes interest once, on the full original principal, for the full term — then spreads that fixed interest total evenly across every monthly payment, regardless of how much principal you've already paid off. This is how nearly every Philippine car loan and most appliance or motorcycle financing is quoted.

A worked example

Take a ₱500,000 loan over 36 months (3 years) at a quoted 6% annual rate — a realistic car loan scenario. Computed as an add-on rate, that 6% produces:

At the same 6% headline rate, the add-on method costs almost double the real interest of diminishing balance — ₱90,000 versus ₱47,594.87 — because it keeps charging interest on principal you've already paid down. To match the true cost of that 6% add-on loan, a diminishing balance loan would need to charge 11.08% per year. This is exactly why a "6% all-in" car loan pitch and an "11% per annum" bank loan quote can end up costing you almost the same amount — they're not the discount and the expensive option they sound like.

You can run your own numbers — any principal, rate, and term — and switch between both methods on the Loan Calculator or the Car Loan Calculator, which defaults to add-on since that's how Philippine dealers quote.

Why lenders use different methods

Add-on rate is simpler to compute and quote up front, and it locks in a fixed, predictable interest total for the lender regardless of early or late payments — useful for high-volume dealer financing where the lender wants certainty. Diminishing balance costs the borrower less overall for the same headline rate, which is part of why regulated bank lending — where competition and disclosure rules are stricter — defaults to it.

What to ask a lender before comparing rates

A lower headline rate isn't automatically the cheaper loan. Before comparing two offers, confirm which method each one uses — ask directly, since it's not always stated as clearly as the rate itself — and compare total interest and total repayment over the full term, not just the monthly payment or the quoted annual rate on its own.