I want to take out a Dh100,000 loan for my rent and a Dh75,000 car loan for a second-hand car and I keep getting confused by the different interest rates on offer. Some of them are advertised as flat rates and some are advertised as reducing rates. What is the difference and how will that difference affect how much I pay back? SA, Dubai
The expert advice
Ambareen Musa, founder and chief executive of Souqalmal.com
This is one of the questions we are asked about the most at Souqalmal.com. When it comes to rates on a car loan, a personal loan or a home loan and so on, there are two ways of calculating it – the flat and the reducing method. Each bank can choose which method they want to advertise their rates. This means that some pick a flat rate and others a reducing rate, so you cannot just compare the advertised rates you see on billboards or advertising campaigns unless you are sure you are comparing like for like, ie flat rates against flat rates.
So what is the difference between the two? A flat rate calculates the interest on the entire loan amount without considering the amount already paid off. For example, if you take out a loan of Dh100,000 for five years at 5 per cent, the interest paid every year for five years is 5 per cent of Dh100,000 – not considering how much you have already paid up by year four.
On the other hand, a reducing balance rate calculates the interest on the outstanding balance of your loan every year, which therefore reduces as you pay off your loan. You will find that advertised flat rates are generally lower, but do not be fooled. The best way to compare different advertised rates to ensure you get the best deal is to convert all your options into either a flat rate or reducing rate before starting your comparison. Souqalmal.com shows both options on the site for you to choose. The general rule of conversion is to divide the reducing rate by 1.81 to get an estimated equivalent of the flat rate.
To make things easier to understand, two loans are advertised: one is a flat rate of 18 per cent and the other is a reducing rate of 24 per cent. Instinctively, you would pick the 18 per cent flat rate option but calculate this properly and you will quickly discover that is not the best rate. If you had to compare apples to apples in this case, you would convert the 18 per cent to a reducing rate (18 per cent divided by 1.81 = 32.6 per cent). You can now compare 32 per cent against 24 per cent as they are both reducing rates and it’s easy to see which is the best option.
The reader’s advice:
Daisy Smith-Jones, Dubai
It’s a tricky issue and one that confused me until I realised the banks were effectively tricking us by advertising different rates. I took out a car loan and when I approached the line of car loan salesmen at a showroom, they all had different rates on offer. While some sounded better than others, one of the salesmen then pointed out that his neighbour’s flat rate was actually not as good as it sounded. He showed me how to make the conversion so that I could directly compare the two car loan products and it emerged that the helpful salesman was the right bank representative to borrow from. It seems the only way to know for sure is to get our your calculator out. Alternatively log on to one of the UAE’s many comparison websites for personal products, as they’ve already done the conversions for you.
The next money clinic:
I have a credit card with an outstanding balance of Dh75,000. Can you suggest any option to get rid of this liability? I have approached so many banks for a personal loan to settle this but the banks say with this much on my credit card, they cannot offer me a loan. RP, Abu Dhabi
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