How Is the Flat Rate Pay Method Calculated?

by Jared Lewis, Demand Media
Flat interest rate loans are fairly uncommon.

Flat interest rate loans are fairly uncommon.

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The flat rate pay method can be used to simplify a business transaction. It can also be used to gain a rough estimate of the number of payments and the amount of each payment that will be due on borrowed money. It provides a much simpler calculation than other types of loans and transactions.


The calculation on a flat rate loan is based on the total principal of the loan itself and the interest rate calculated for each individual pay period. For example, a loan of $1,200 at a rate of 5 percent for one year would be paid on the basis of paying back $100 per month for 12 months. At a rate of 5 percent, the monthly interest payment would be $5. Therefore, the entire monthly payment would amount to $105. This would result in a total interest payment of $60 for the entire year.

Diminishing Rate Loans

The more common diminishing rate loan recognizes that the principal of the loan will drop by a certain amount each month, depending upon how much is paid back on a monthly basis. Therefore, the actual amount of interest charged on a monthly basis gradually declines over time. In this type of loan, you end up paying the lion's share of the interest during the initial repayment period of the loan. Only toward the end of the loan do you start to see a substantial decline in the amount of the principal.


One of the primary advantages of the flat interest rate loan over other types of loans is the simplicity of the calculation. The interest for every payment period of the loan is the same and is based on the original principal. This interest is simply tacked on the principal payment for each pay period and this diminishes the total amount of the loan over a fixed and predetermined period of time. Flat interest loans simplify the borrowing and lending process.


The flat interest rate loan does have at least one disadvantage in that it eliminates the advantages gained from paying down the loan's principal faster than is required by the terms of the note. Paying additional monthly payments on a flat-rate loan does not reduce the overall amount of interest that is paid on the loan. This basically allows the lender to maximize the interest rate throughout the life of the loan, even if the borrower is able to repay early.

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