Flat Rate (finance)

Flat Rate (finance)

Flat interest rate loans are often used by traditional moneylenders in the informal economy of developing countries. They are also used by many microfinance institutions. One reason for their popularity is their ease of use. For example, a loan of $1,200 can be structured with 12 monthly repayments of $100, plus interest, due on the same dates, of 1% ($12) a month, resulting in a total monthly payment of $112. In the example to the right, the loan contract is for 400,000 Cambodian riels over 4 months. Interest is set at 16,000 riels (4%) a month while principal is due in a single payment at the end.

Flat rate calculations, which are based on the amount of money the borrower receives at the beginning of the loan rather the average amount the borrower has access to during the loan, have been outlawed in developed countries (see for example the Truth in Lending Act). However, they persist in many developing countries, and have frequently been adopted by microcredit institutions.

For a variety of reasons (see below), flat rates can be useful in lending to poor people, and often disappear very slowly as financial systems develop.