Flat Rate

Meaning and Definition

In the context of car finance, a flat rate refers to an interest calculation method that applies the interest charge on the original loan amount throughout the entire loan term. The interest is calculated based on the initial principal balance and remains constant throughout the repayment period. It does not take into account the reducing loan balance as repayments are made.

Why it is important to know

Understanding the concept of a flat rate is important as it helps borrowers assess the total interest cost of the loan and compare different financing options. However, it's important to note that the flat rate does not reflect the true cost of borrowing, as it does not consider the reducing loan balance over time.

Example in car finance

Suppose you borrow £10,000 for a car finance agreement with a flat interest rate of 6% per annum and a loan term of 5 years. The interest charge would be calculated on the original loan amount of £10,000 throughout the entire loan term. Thus, the interest charge would amount to £600 per year (£10,000 x 0.06) or £3,000 (£600 x 5 years) over the full loan term. It's important to consider other factors, such as the reducing loan balance and the effective interest rate, to assess the true cost of borrowing.