Flat interest rate

Flat interest rate
See also

Flat interest rate - in finance, a specific type of interest rate which is always provided as a fixed percentage and expressed as an annual rate. The borrower pays the fixed percentage of the original amount throughout the whole loan or mortgage as a monthly interest payment, despite the total amount owned is decreasing as time goes on. Interest payments amount remains the same throughout the loan tenure if paid on time. The flat interest rate is popularly used for loans taken out by individuals.

Flat rate interest calculation

Below formula allows to calculate \( IP \) as a flat interest amount per installment based on flat interest rate\[ \frac{(L \cdot Y \cdot IR)}{N} = IP \]

where \( L \) - original loan amount, \( Y \) - number of years, \( IR \)- interest rate and \( N \) - number of installments.

Advantages of flat interest rate

Currently, with its low complexity, the flat interest rate has the following main advantages [1]:

  • it's easy to calculate
  • it keeps loan terms clear and transparent for both borrower and lender

Disadvantages of flat interest rate

Flat interest rate has also a few disadvantages of significant importance for lenders [2] [3]:

  • the total cost of credit may change due to irregular - early or late payments, but the term "flat" is often mistaken for "fixed" while the method of calculation total credit cost is applicable only if installments are played on time
  • the flat rate often gives an impression that the rate is lower than it actually is and it could be hard to compare rates
  • it does not consider charges associated with the loan

Footnotes

  1. House of Commons, 2012
  2. Dichter T., Harper M., 2007
  3. Daly M., Walsh J., 1988

References

Author: Anna Strzelecka