### 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 1

^{st}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**.

• 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.*

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.

*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*