A flat loan is an an interest free loan. Every lender has to contend with the risk, no matter how small, that a borrower will not repay the debt. Lenders typically charge interest on loans so that the interest payments made by one borrower will help to offset any losses that are incurred as a result of another borrower defaulting on a loan. Consequently, lenders that write flat loans have to contend with a higher risk of financial loss than lenders that charge interest.
Manufacturers and retailers sometimes allow consumers to buy goods with flat loans. A consumer who lacks the cash to buy a product outright can use a flat loan to pay for the product incrementally over a period of time. Retailers use flat loans as a device for selling excess inventory. In many instances, the loan is only flat for a certain period of time and borrowers are subject to interest charges if they fail to pay off the debt within the flat interest period. Generally, lenders will only allow a borrower with good credit history and a stable source of income to take out a flat loan.
Investment firms often use flat loans during short sale transactions. In a short sale, an investor borrows a security from a brokerage firm and sells that security to another party. The investor must buy back the same security and return it to the brokerage firm at a later date. Investors enter into such transactions if they believe that securities prices are about to drop because they can buy back the security for less than they sold it for. Short sale or margin loans are usually flat interest loans although brokerage firms may charge application or processing fees.
Individuals sometimes enter into informal flat loan agreements with friends or relatives. Someone planning to buy a first time home or car may lack the necessary funds to make the required down payment and may borrow funds from a friend or family member. The individual may promise to repay the debt at a later date and the lender may choose not to assess any interest on the debt. Contract laws vary between nations but such informal contracts have no legal basis in some countries while elsewhere verbal loan agreements are legally enforceable.
Lenders, retailers and other lenders involved in a flat loan agreement normally limit the loan term to a few years or less. Assuming that the borrower repays the debt then the lender does not lose any money during as the result of a flat loan agreement. Nevertheless, inflationary pressures usually cause prices to rise over time. This means that the longer the loan term, the more spending effective spending power the lender stands to lose as a result of inflation. Consequently, many lenders limit flat loan terms to 24 months or less.