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Financial education
Interest is the price of using someone else's money. Here is how it is calculated, why two loans quoting "3% per month" can cost very different amounts, and what to ask before you sign.
This article mentions borrowing. It is educational and is not a loan offer or credit advice. Loan terms vary by lender. Always read the full agreement and confirm you can repay before borrowing.
Interest is the price you pay for using money that is not yours. That is the whole idea. Everything difficult about interest comes from how that price gets calculated — and lenders do not all calculate it the same way.
Two loans can both advertise "3% per month" and cost you meaningfully different amounts. Understanding why is probably the single most valuable piece of financial knowledge for anyone who borrows.
Interest is charged on the original amount for the whole period, regardless of how much you have already paid back.
Interest is charged only on what you still owe. As you repay, the balance falls, so the interest charged each month falls too.
Take a loan of UGX 1,000,000 at 3% per month over 6 months.
Flat interest:
Interest is 3% of the original UGX 1,000,000 each month, for all 6 months.
Reducing balance:
You repay principal of about UGX 166,667 each month, and interest is charged only on what remains.
| Month | Balance owed | Interest at 3% |
|---|---|---|
| 1 | 1,000,000 | 30,000 |
| 2 | 833,333 | 25,000 |
| 3 | 666,667 | 20,000 |
| 4 | 500,000 | 15,000 |
| 5 | 333,333 | 10,000 |
| 6 | 166,667 | 5,000 |
| Total | 105,000 |
The rate is one component. A loan can also carry:
All of these are part of what the loan costs you. A loan with a low rate and heavy fees can be worse than one with a higher rate and none.
Ask this, and insist on a number:
"If I borrow this amount and pay exactly on schedule, what is the total amount of money I will have handed over by the end?"
Then subtract what you received. That difference is the true cost of the loan, with every fee, charge and calculation method already baked in. Now you can compare two offers honestly.
A lender acting in good faith will:
A lender who will not do these things has told you something important.
