What is a Flat-Rate Loan
Transcript of What is a Flat-Rate Loan
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Explaining a Flat-rate Loan
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Furnishing Loan
Financing institutions (FIs) in Singapore generally offer these
loans with tenure ranging from oneto fiveyears.
As this duration is considered relatively short, the FIs usually
offer these loans on flat- rate basis.
Some banks may also offer them on monthly-restbasis.
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What is a flat-rate loan?It is a loan in which total interest payment is determined at the
beginning of the loan based on the total
principle.
The effective interest on a flat rate is higherthan a loan based on periodic-rest, all else equal.
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Example
We will use the below loan details to understand the payment for
a flat-rate loan.
Loan Quantum = S$20,000
Loan Tenure = 3 years
Interest Rate = 10% p.a.
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Total Interest=Principal xTermof Loan InYears x Nominal Interest Rate p.a.
Total Interest=$ 20,000x3x10%=$6,000
Total Payment=Principal+Total Interest
Total Payment=$ 26,000
Instalment=
Principal x(1+Term of Loan InYears x Nominal Interest Rate p.a.)Total Numberof PaymentPeriods
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The installment in each period =the Total Payment /the number
of payment periods.
Most loans are serviced monthly.
So, the number of payment periods = 12 x 3 = 36. The monthly
installment = $26,000 / 36 = $722.22
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Sometimes flat-rate loans can be repaid:
Quarterly
Semi-annually
Annually
The total number of payment periods
= Term of Loan in Years x Payment Frequency Per Year
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Most loans are serviced monthly
So, the number of payment periods = 12 x 3 = 36.
The monthly installment = $26,000 / 36 = $722.22
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Finding the interest rate on a flat-rate loan
We will move onto learning:
The computation of the ENR per annum
Effective interest rate per annum.
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To compare the true cost among various loan types, we need tostandardize the interest rates.
This is where the ENR (equivalent nominal rate) per annum and
effective interest rate per annum come in.
Loans come in different types, for example a flat rate versus a
periodic-rest
Within the same type there can be differences in the annualpayment frequency or the mode of payment (annuity-immediate
versus annuity-due)
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Here, we assume the case of annuity-immediate
Using the same example:
Loan Quantum = S$20,000Loan Tenure = 3 years
Interest Rate = 10% p.a.
This time round instead of having only monthly repayments, we
will have quarterly, semi-annual and annual as well.
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Table 1
Payment Per
Period ($)
Total Number of Payment PeriodsPayment Frequency Per Year
722.2236Monthly
2,166.6712Quarterly
4,333.336Semi-annual
8,666.673Annual
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How do we then find their ENR?
The Excel syntax to be used to find ENR.
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Table 2: Excel Syntax for ENR
Syntax
=12* RATE (36, 722.22, -20000)Monthly
=4* RATE (12, 2166.67, -20000)Quarterly
=2* RATE (6, 4333.33, -20000)Semi-annual
=1* RATE (3, 8666.67, -20000)Annual
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We will use ENR as the nominal rate in the computation of theeffective interest rate
So the effective rates
Effective Rates (%)
19.46Monthly
18.28Quarterly
16.76Semi-annual
14.36Annual
Table 3
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The relation between the true cost of the flat-rate loan and
the payment frequency
The more frequent are the payments the higher the costis.
This has to do with the fact that total interest payment has beendecided right from the start; therefore the more frequent the
repayments are the less liquidity you have.
Seen in another way, it has something to do with the time valueof money.
$1 pays today costs more than $1 pays a year later
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Click HEREfor the Excel spreadsheet to computethe payment and effective rate for the flat-rate
loan.
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