A flat interest rate is any interest rate that does not change over time. The term is frequently used to describe certain loans that do not take into account the recipient’s average access to the loan money over time. These loans are commonly used in microfinance, especially in lending to those in developing countries. While there are some advantages to using flat interest rate calculations, such as ease and increased payment flexibility, there are also disadvantages, because the amount of interest due does not decrease as the loan is paid off like with conventional loans.
Flat interest rate repayment systems are generally simpler to calculate than traditional plans because they take the interest rate and multiply it by the entire loan. This amount is then evenly spread out for the duration of the loan. For example, a loan for $10,000 US Dollars (USD) with a 5% interest rate would require a total of $500 USD to be paid in interest. If the loan repayment period was over the span of 10 months, then the recipient would pay $1,000 USD per month as well as $50 USD per month in interest. These loans also have the potential to be paid at the end of the lending period, and in this case, the loan recipient would pay $50 USD per month and $10,000 USD at the end of the period.
This contrasts with the traditional loan repayment process, during which individuals only have to pay interest on the money they have not repaid to the lender. For this reason, some people feel that flat interest rate loans are deceptive or unfair because loan recipients will end up paying more interest with this system if all other factors are held constant. An additional disadvantage of flat interest rates is that they do not encourage recipients to pay back the loan early to avoid paying extra interest. As a result, people are more likely to wait to repay the loan in full, sometimes incurring high opportunity costs in the process.
These disadvantages are countered by several benefits, including ease of calculation and a more flexible payment plan. Since flat interest rates can be calculated simply and effectively, continuous monthly recalculations are not needed, saving lenders time and reducing the potential for error. Many farmers can benefit from this system because they have the flexibility to pay down their loan towards the end of the lending period after harvesting crops. Overall, the total interest due with flat interest rate loans is not that different from traditional loans because all lenders will adjust their marketing strategies, interest rates, and lending periods to maximize profits.