what is a flat-rate loan

8/13/2019 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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