Aishwarya August 18, 2022 0 Comments

The Difference Between a Flat Rate And a Reducing Rate Of Interest

The phrase “interest rate” is used relatively frequently in the realm of personal finance and banking. There is a wide range of enticing financing options available from banks in the UAE, whether you are looking to purchase a new home or a vehicle. In point of fact, the majority of people who are in the market to purchase property in Dubai check into their possibilities for house mortgage loans. However, before you sign any of the official documentation, you need to give some thought to the type of interest rate that you want to utilize. There are two ways that the interest on a mortgage can be computed: a flat rate of interest, or a falling rate of interest. The interest rate that is charged on a loan with a flat interest rate is guaranteed to stay the same throughout the duration of the loan since the interest is always computed with reference to the principal amount of the loan.

On the other hand, a decreasing rate of interest is one in which the total amount of interest that must be paid is computed not against the initial principle amount of the loan but rather against the amount of the loan that is still outstanding. When compared to its counterpart, a flat rate of interest may occasionally be presented as a lower and more alluring rate.

  • How Do you Choose Between a Flat Interest Rate and a Rate That Decreases Over Time?

First and foremost, you need to have an understanding of how the various interest rate structures function. After that, you’ll be able to figure out how much you’ll have to pay back for your personal loan in Dubai or any of the other Emirates over the course of its duration.

  • Where Is Fixed-Rate Interest Most Commonly Used?

 When it comes to determining the amount of interest that is owing on personal and automobile loans, the flat rate technique is by far the most effective option. If you choose to proceed in this manner, you will be responsible for making interest payments on the total loan amount over the term of the loan. The fact that the interest rate does not decrease even if the loan is progressively paid off is one of the primary reasons why it is less popular among borrowers. When compared to their equivalents in terms of the Effective Interest Rate, the flat interest rate is often between 1.7 and 1.9 times higher.

  • Where Might One Make Use of a Decrease in the Interest Rate?

 The decreasing rate method is used to compute the interest that must be paid on credit cards, mortgages, and other types of loans secured against real estate. If you employ this strategy, the only cost you will incur is the interest due on the principal amount of the loan. When referring to loans of this nature, it is common practice to reference the Effective Interest Rate, which is equivalent to the interest rates applied to Fixed Deposits (FDs) and Savings Accounts.

  • How does Interest work?

Understanding the difference between how interest is computed and how interest rates are progressively modified should be the first step in this process. The first is a factor that is considered when determining the amount of interest to be charged, and the second is the mortgage product itself. You might also combine elements of both of these. For example, a “flat rate” refers to a method of calculating interest, whereas a “fixed rate” refers to a type of mortgage product. That allows you the option of a rate that is always the same. It is important to keep in mind, however, that not all flat prices are set, and vice versa.

  • Illustration of a Flat Rate

 When you calculate your EMI with a flat rate of interest, the result is the same as when you use a straightforward calculator to do it. Take, for instance, the scenario in which you obtain a loan of AED 200,000 at an interest rate of 5% for a term of 5 years. This indicates that you are required to make annual interest payments of 5% on the loan, regardless of the amount that you pay toward it. Therefore, the total amount of interest that has to be paid is 50,000 AED. The formula for determining it is as follows: Take the total loan amount (200,000) and multiply it by 5%; this will give you the amount in AED. After that, increase that figure by the number of years, for example, 10,000 times five to get AED 50,000. No matter how much you cut it, this will result in an interest payment of a total of 50,000 AED being made over the course of the following five years.

  • An Illustration of a Decrease in the Interest Rate

 On the other hand, the operation of this kind of interest is completely different. Your total outstanding balance will decrease by the amount of principle repayment that you make with each EMI payment, and interest will only be computed on that amount starting the following month after it has been reduced. As a direct consequence of this, the total amount of interest will be reduced proportionally. Consider the following scenario: we submit an application for a loan in the amount of 100,000 AED with a reducing balance rate of 5% and a payback term of 5 years. If you are paying an interest rate of AED 20,000 per year, then the interest for the first year will be AED 5,000. This shows that our balance is AED 80000, which is equal to AED 4000 (5 percent of 80000). The same calculation is going to be carried out for each succeeding year. Because of this, your total interest payment over the duration of the loan will be 15,000 AED rather than the 25,000 AED that would have been due if it had been a flat rate.

  • Important Points to Consider When Deciding Between a Flat Rate and a Reducing Rate

You are now ready to go on to the next phase since you have a fundamental understanding of both the fixed rate and the decreasing rate of interest. Let’s shift our attention to the primary differences that exist between loans with a flat rate and those with a declining rate-based structure in this section of our analysis. The following is how it works:

– Calculation

Loans with a fixed interest rate are ones in which the whole amount of the loan that the lender agrees to finance is used to calculate the interest rate. On the other hand, when there is a decrease in the rate, the interest is computed based on the total amount of principle that is still owed on the loan. Since the effective interest rates on effective reducing rate loans are lower than the effective interest rates on flat-rate loans, these loans are more lucrative.

– The Complicated Nature of the Computation

The interest rate that remains constant, as opposed to one that gradually decreases, comes out on top in this comparison. Why? because the amount of interest is fundamental and simple to compute when expressed as a flat rate. However, the computation for the lowering rate is difficult since the interest is computed by first taking the entire amount of the loan and then deducting the principal amount that was paid for the most recent payment from that total.

– Which One Is the Best in the United Arab Emirates?

It is common practice in the United Arab Emirates for the fixed interest rate to be lower than the variable rate of interest. On the other hand, everything relies entirely on the percentages of interest rates that are being offered.

 

 

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