Benefits of Flat Rate Lending
Flat interest rates persist in emerging and informal financial systems due to the following advantages:
- They are easy to calculate and track: Flat interest rates require no calculations to blend principal and interest into a level payment, and require no compounding calculations (see the example to the right). Traditional moneylenders often do not have either computers or calculators, and neither do their borrowers, who are often illiterate and/or innumerate. Flat rates keep loan commitments clear, transparent and easily tracked by both parties. Many microfinance institutions do not have computers either, and the complexity of declining balance calculations may confuse their borrowers and even their staff. Semi-formal institutions like self-help groups, village banks and ASCAs also usually prefer this calculation method.
- They meet vital cash flow needs of farmers: Many borrowers in developing countries are farmers who demand loans with balloon payments, repayable after they harvest their crops. Because the borrower is using the entire amount of principal borrowed throughout the entire loan term, flat rate calculations are accurate when applied to balloon loans.
- They support 'in-kind' loan transactions: Flat rate loans originated before currency was invented, and are commonly used to repay loans in regular instalments of chickens, eggs, kilos of rice, and so on. For farmers accustomed to these types of transactions, flat rate cash loans are familiar and easy to understand.
Read more about this topic: Flat Rate (finance)
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