Solar Loan Interest Rates: Add-On vs. Diminishing Balance, Explained

Two lenders can quote what sounds like the same number and charge meaningfully different amounts, because “1.25% a month” means something different depending on what that 1.25% is charged against. This is the single most useful thing to understand before comparing solar loan offers, and it’s the part most advertised rates don’t spell out.

Add-on interest: charged on the original amount, every time

An add-on (or “flat”) rate charges interest on the full original principal for every remaining month of the loan, regardless of how much you’ve already paid back. If you borrow ₱300,000 at a 1% monthly add-on rate over 36 months, you’re charged ₱3,000 in interest every single month, month 1 through month 36, even though by month 30 you’ve repaid most of the principal.

Total interest on that example: ₱3,000 × 36 = ₱108,000, on top of the ₱300,000 principal, for a total repaid of ₱408,000. This is the arithmetic our installment plans guide and BDO solar loan guide both walk through for real published add-on rates.

Diminishing balance: charged only on what’s left

A diminishing-balance (or “reducing balance”) rate charges interest only on the outstanding principal at each point in the loan. Early payments carry more interest because more principal is still outstanding; later payments carry less, because you’ve paid most of it down. This is how a standard amortizing bank loan or home loan is structured, and it’s the method our solar loan calculator guide walks through the formula for.

For the same headline rate, diminishing balance always costs less in total interest than add-on, because add-on keeps charging you on money you’ve already returned.

Why the same-looking rate isn’t the same cost

Take BDO’s own published Personal Loan rate sheet, cited in our BDO solar loan guide: a 1.25% monthly add-on rate over 36 months discloses as a 25.98% effective rate per year. That gap between 1.25% a month (which sounds like roughly 15% a year if you just multiply by 12) and a 25.98% effective annual rate is entirely the add-on mechanism at work. BDO publishes both numbers side by side, which is unusual — many lenders only advertise the smaller monthly figure.

The rough shape of why: a monthly add-on rate approximately doubles when converted to an effective annual rate, because on average across the loan you’ve only “used” about half the principal you’re being charged interest on the whole time. The commonly used approximation for this conversion (the “N-ratio” method used in truth-in-lending disclosures) is:

Effective rate ≈ (2 × N × monthly add-on rate) / (N + 1)

where N is the number of monthly payments. For a 1.25% monthly add-on rate over 36 months: (2 × 36 × 1.25%) / 37 ≈ 2.43% a month, or roughly 29% a year — in the same range as BDO’s own disclosed 25.98-26.63%, though not an exact match, because this is an approximation, not the same present-value calculation a lender’s own disclosure runs. Treat this formula as a way to sanity-check an offer, not as a substitute for the lender’s own disclosed EIR.

The one question that cuts through both

You don’t need to run the formula yourself if you ask the lender directly:

“Is this rate add-on or diminishing balance, and what is the effective interest rate?”

Under the Truth in Lending Act (Republic Act 3765) and BSP regulations, lenders are required to disclose the effective interest rate, so asking for it by name is a reasonable request, not a special favor. A lender that states both the method and the EIR plainly, the way BDO’s rate sheet does, is giving you what you need to compare offers directly. One that resists naming either is worth a second look before you sign.

Fees the effective rate doesn’t always capture

Effective interest rate is the right number to compare loans on, but check what it includes. Some lenders fold processing fees, documentary stamp tax, and insurance into the disclosed EIR; others quote EIR on interest alone and list fees as separate line items deducted from the loan proceeds. Our BDO solar loan guide is a concrete example: on top of its disclosed effective rate, BDO’s Personal Loan deducts a processing fee and documentary stamp tax from what actually lands in your account, and charges a separate early-settlement fee if you pay it off ahead of schedule. None of that changes the EIR figure itself, but all of it changes what you actually receive and what it costs to exit early. Ask for the net proceeds after fees, not just the loan amount and the EIR, and ask specifically about prepayment charges if there’s any chance you’ll pay the loan off early — solar savings sometimes make that possible sooner than the original term assumed.

Comparing offers properly

Once you have the effective interest rate from each lender, compare that single number, not the advertised monthly percentage, and not the monthly payment amount alone — a longer term can produce a lower monthly payment on a loan that actually costs more in total. The solar financing calculator does this arithmetic for you once you enter the amount, rate, and term, and our solar loan calculator guide shows the underlying formula so you can check it by hand.

For the routes this site has verified actual rates on, GSIS Ginhawa (5% a year) and Pag-IBIG’s Multi-Purpose Loan (10.5% a year) are priced well below a typical bank personal loan’s effective rate — see solar loan vs. personal loan for that comparison in full, and solar financing options in the Philippines for how every route compares beyond rate alone.