Reducing balance vs flat rate
The single most useful thing to understand about borrowing in the UAE is that the same percentage can mean two completely different things depending on how the bank quotes it.
Reducing balance
Interest is charged only on what you still owe. In month one you owe the full amount, so the interest is large; by the final month you owe very little, so it is tiny. This is the honest way to price a loan, and it is what the standard instalment formula assumes:
Payment = P × r ÷ (1 − (1 + r)^−n)where P is the amount borrowed, r the monthly rate (annual ÷ 12) and n the number of months.
Flat rate
Interest is charged on the original amount for every month of the term, regardless of how much you have paid off. Borrow AED 100,000 over 4 years at a 6.5% flat rate and you pay 6.5% of AED 100,000 every year for four years — even in the last month, when you might only owe a couple of thousand.
As a rough rule, a flat rate is worth roughly double the same number quoted as reducing balance. A 4% flat rate is somewhere near an 7.5% reducing rate. This is exactly why the advertised figure in a shop window is almost always the flat one.
What to ask a lender
- Is that rate flat or reducing?
- What is the total amount repayable over the full term?
- What are the arrangement and life-insurance fees?
- What does it cost to settle early?
The second question is the one that cuts through everything. A single total figure is hard to dress up.
Sources
Written and maintained by Mohammed Jamil. Found a mistake? Email [email protected].