3F’s (Fixed, Floating, Flat) & Reducing Balance Loans

14 August, 2015

3F’s (Fixed, Floating, Flat) & Reducing Balance Loans
The two most important questions to ask before taking a loan.

Monexo is all about trust and transparency.

In an effort to educate the public, we publish this post with the aim of simplifying two sets of terms often used interchangeably to provide borrowers with greater transparency while borrowing money. Borrowing money is good because it helps you realize your dreams and goals faster but it is important that you understand the terms of your loan agreement.

Fixed vs. Floating Interest Rates 
• A fixed interest rate loan is a loan in which the interest rate charged on the loan will remain constant for the loan’s entire term and duration – regardless of any interest rate fluctuations.
• Monthly payments, therefore, remain constant throughout the term of the loan.
• On the other hand, a floating (variable) interest rate loan is a loan in which the interest rate is allowed to fluctuate depending on market movements.

• Assume that you take out a loan at an annual interest rate of 10% for two years.
• In those two years, if the market interest rate rises, your monthly payments now increase.
• Although the reverse is true for reducing market interest rates, a fixed interest rate loan is generally preferred because it is resistant to market fluctuations.
• Mortgage loans in Hong Kong are often provided with variable interest rates due to the long tenor, so monthly payments are subject to change.
• Personal loans and credit card are provided on fixed interest rate because of short tenors.

At Monexo, however, we only offer fixed interest rates, because we aim to ensure that borrower’s loans are guarded against interest rate fluctuations.

Flat Interest Loans vs. Reducing Balance Loans
The more important, and slightly harder to understand set of terms (flat or reducing balance) concerns the monthly interest payment that borrowers make towards their loans.

• Under the reducing balance method, the interest payment each month is calculated based on the outstanding principal loan balance.
• As the borrower repays the installments, the remaining principal declines with time.
• Interest is then only charged on the outstanding amount that the borrower currently owes – and so they end up paying interest only on the actual principal balance unpaid.

• Assume that a borrower takes out a loan of $1 million, for 48 months on January 1st 2015.
• The interest rate at an interest rate of 4.5% per year on the reducing balance method.
• Therefore, each month, the payment that borrowers make to the lender is $22,803.50 (or $273, 642 per year).

• As you can see from the table below, the total yearly payment undergoes no change.
• But, when you look at the breakdown of the payments – as the years go by, more and more of the principal is paid for using each payment, and the borrower is charged less interest.
Principal vs Interest

• In contrast, most banks and money lenders in Hong Kong use the flat rate method of charging interest.
• Interest, under the flat rate, is charged on the full value of the loan throughout the loan tenor, as opposed to the money that the borrower currently has on hand.

Referencing the example used earlier, the total interest payment would then be $180,000, a whopping 90% more, as compared to the reducing balance method used at Monexo.

Illustration of Interest Payment

The most cost-effective, and borrower-friendly loans are those that offer fixed interest rates, and calculate interest payments using the reducing balance mechanism. Here, we see the three different loan options one can gather, and their sources. 
Matrix of Measure

Monexo is the only organization which prevents borrowers from paying interest on principal already paid back, and from facing fluctuating interest rates.

If you ever choose to take out a loan, always remember to ask yourself two questions:
•  Is the interest rate attached with my loan floating or fixed?
•  Are my interest payments on a flat rate or reducing balance?

You will generally find that you want a loan that offers a fixed interest rate, on a reducing balance basis. This is exactly what Monexo offers you.

That is all that this post has to offer. Stay tuned for our next post, which distinguishes Monexo from the rest, in terms of loan pre-payment.

Author: Sahil Mohnani @ Monexo