Difference between flat and reducing rate

rates (1)

Before taking a loan, whether it’s a personal, car or home loan, you need to keep in mind that there are two types of interest rates attached to loans; flat and reducing. But what are they and what is the difference? Let us explain so you can make the right decision.

Flat rate

With a flat rate, the rate applied and paid stays the same. It’s based on the original loan amount and doesn’t change over time or decrease as the loan gets paid off every month. For example, if you take a loan of AED 200,000 for five years at 5%, the interest paid each year will remain at 5% of AED 200,000, regardless of the amount paid by the fourth year. Flat rates are usually lower than the reducing rate, but you will have to pay the same interest rate each month.

Reducing rate

A reducing rate is when the interest rate of the loan decreases as you pay each monthly instalment. So basically, the interest for the coming month would be calculated based on the updated unpaid loan amount. For example, if you take loan of AED 200,00 for five years with a reducing rate of interest of 5%, then the amount you pay will be reduced each year…because the total loan amount will have been reduced.

Calculating the difference

For the reducing rate, divide it by 1.81 to get an estimated equivalent of the flat rate so you can be able to compare which rate is less expensive.

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