A loan can be repaid with the same installment every month or with installments that start high and fall over time. The loan amount, rate and term can be identical, yet the total interest paid and the monthly burden are different. Use the calculator below to run both methods side by side with your own figures.
Fill in the empty fields to see the result.
| Year | Paid | Interest paid | Balance |
|---|
Annuity: A = P × i / (1 − (1 + i)^−n), i = annual rate / 12. Declining: P / n of principal + interest on the remaining balance. Fees and insurance are not included.
Loan repayment types: the basic terms
Every installment has a few parts:
- Principal: the amount you borrowed.
- Interest: the price of borrowing, charged on the outstanding balance, the principal not yet repaid.
- Installment: what you pay each period. It covers that period's interest plus some principal.
The repayment method decides how much principal goes into each installment. That choice changes how fast the balance falls, and so how much interest builds up. For the wider picture, see How Loans Work.
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Annuity loan: equal installments
In an annuity loan, every installment is the same amount for the whole term, as long as the rate does not change.
How the split moves over time:
- Early installments are mostly interest, because the balance is at its highest.
- Each payment reduces the balance a little, so the next interest charge is a little lower.
- Because the installment stays fixed, the principal share grows as the interest share shrinks.
- Near the end, installments are mostly principal.
Equal installments make budgeting simple, and the starting payment is lower than with the differentiated method. The cost is that the balance falls slowly at the start, so interest is charged on a larger balance for longer.
Differentiated payments: declining installments
With differentiated payments, the principal is divided into equal parts, one for each period. Each installment is that fixed principal part plus interest on the current balance.
- The principal part stays the same every period.
- The interest part falls every period, because the balance drops by a full principal part each time.
- The total installment is highest at the start and declines steadily to the end.
The starting burden is heavier, which matters for affordability checks. After that, every installment is smaller than the one before.
Equal installments vs reducing balance: a common confusion
In Pakistan, "reducing balance" often describes how interest is calculated, not how installments are shaped. Both methods above charge interest on the reducing balance. The real contrast is with a flat rate, where interest is calculated on the original principal for the whole term, even as you repay it. A flat rate quote can look lower than a reducing-balance rate but cost more in practice. To compare offers on equal terms, see APR and Effective Rate and Effective Loan Rate.
Total interest comparison
For the same amount, rate and term, the differentiated method gives lower total interest. The reason is mechanical. Principal is repaid faster at the start, so the average outstanding balance over the term is smaller, and interest is always charged on that balance.
| Feature | Annuity | Differentiated |
|---|---|---|
| Installment size | Same each period (fixed rate) | Highest at start, then declines |
| Principal repaid early | Less | More |
| Starting burden | Lower | Higher |
| Total interest | Higher | Lower |
| Budgeting | Simple | Needs room for larger early payments |
The gap widens with a higher rate and a longer term. Mortgages show it most clearly. Enter your own amount, rate and term in the calculator above to see the exact difference and the yearly schedule for each method.
Floating rates and policy changes
Many bank loans in Pakistan carry a floating rate, often a benchmark such as KIBOR plus a bank margin. KIBOR usually moves in line with the State Bank of Pakistan's policy rate. The latest SBP decision on record here is: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC).
When the rate resets on a floating loan:
- Annuity: the bank recalculates the installment for the remaining term, or sometimes changes the term instead. Ask which one your bank does.
- Differentiated: the principal part stays the same and the interest part is recalculated on the current balance.
More on how SBP decisions affect rates is on SBP rates and economy.
Early repayment
Paying extra principal reduces the balance, and so all future interest, under either method. With an annuity loan, the bank may lower your installment or shorten the term. The choice affects total interest, so check which option the contract allows. Also look for prepayment charges. See Early Loan Repayment.
What to check in a bank's schedule
- Whether interest is on a reducing balance or a flat rate.
- Which installment method is used, and whether you can request the other.
- Whether the rate is fixed or floating, the benchmark used, and how often it resets.
- Fees, insurance and other charges added to installments.
- Prepayment rules and charges.
- The full amortisation schedule, which shows principal, interest and balance for every period.
Whichever method you are offered, the highest installment must fit your income. The starting payment under differentiated repayment is the one to test. See Debt-to-Income Ratio. Islamic financing products use different structures and terms; see Payments, tax, Islamic banking.
Using borrowed money for leveraged forex or CFD trading carries its own danger. Such positions can lose money fast, and the loan installments still fall due. Read Risk management before mixing debt with trading.
Frequently asked questions
Which method has lower total interest?
Differentiated payments, for the same amount, rate and term. Principal falls faster, so interest is charged on a smaller balance.
Why do most consumer loans use annuity payments?
A fixed installment is easy to plan around, and the starting payment is lower, which helps borrowers pass affordability checks.
Is "reducing balance" the same as differentiated?
No. Reducing balance describes how interest is calculated. Annuity and differentiated loans both normally use it. The opposite is a flat rate.
Does an annuity installment ever change?
On a fixed rate, no. On a floating rate, it is usually recalculated when the benchmark resets, unless the bank adjusts the term instead.
How can I see the exact numbers for my loan?
Enter the amount, rate and term in the loan calculator on this page. It shows both methods, total interest, a yearly schedule and the effect of early repayment. Compare the result with the bank's own schedule.