effective interest
Interest calculated on the remaining loan principal, not on the original principal.
What it means
Effective interest is a method of calculating interest based on the remaining loan principal each period. Because the principal decreases as installments are paid, the interest portion also shrinks over time. This method is considered to better reflect the true cost of borrowing compared with flat interest.
Why it matters for families
Understanding effective interest helps families compare loan offers fairly. Two loans with the same interest rate can feel different in cost if the calculation methods differ. Misunderstanding can lead families to choose a loan that looks cheap but has a larger total interest.
Example
For example, a Rp120 million loan with 10 percent effective interest per year and a one-year tenor. Interest is calculated on the remaining principal, so total interest is smaller than the flat method at the same rate. The monthly installment stays the same, but the mix of interest and principal changes each month.
Common misunderstanding
It is often assumed that effective interest is always more expensive than flat interest. In fact, at the same rate, total effective interest is usually lower because it is calculated on the remaining principal.