In this guide 6 sections
A flat schedule charges interest on the original principal for the whole term. Reducing balance charges only on the outstanding principal each period. Daily accrual charges on the balance for each day it stands. A loan system must store the method, the day count and every event that changes the balance.
Three schedules, three different meanings of the same rate
Flat interest takes the principal, applies the rate for the full term, and splits the total into equal instalments. The borrower pays interest on money already repaid. That is why a flat rate looks low next to a reducing balance rate.
Reducing balance recalculates interest on what is still owed after each instalment. Early instalments are interest heavy. Later ones are principal heavy. Daily accrual goes one step further and counts the actual days between payments.
Quote one rate and the three methods give three totals. Your system must hold the method as a field on the loan, never as an assumption in code.
What a part prepayment does under each
Under reducing balance, a part prepayment lowers the principal at once. You then choose between a shorter tenure with the same instalment, or the same tenure with a lower instalment. The system must regenerate the schedule and keep the old one for history.
Under daily accrual, interest stops growing on the prepaid amount from the receipt date. A payment dated late in the day or after cut-off time can shift a day of interest.
Flat loans are awkward. Lenders usually apply a stated rebate rule rather than recalculating. The rule itself must be stored per product.
- Method: flat, reducing or daily
- Day count basis for accrual
- Rebate rule for early closure on flat loans
- Choice of shorter tenure or lower instalment
- Cut-off time for payment dating
A missed instalment changes more than the due date
A missed instalment under reducing balance leaves principal higher than planned, so the next interest charge is higher too. Under daily accrual, interest runs on the unpaid amount every day until it is cleared. Under flat, the interest is fixed, so penal charges do most of the work.
Record the overdue amount in parts: principal, interest, penal charge and fees. Allocate each receipt in a stated order, and store that order per product. If allocation changes between collectors, nobody can reproduce a customer’s balance.
Compute penal charges by rule, never by hand. Store the rate, the base it applies to and whether it compounds.
Insurance premiums and foreclosure figures
Credit linked insurance premiums are often collected with the instalment. They are not interest and not principal. Keep them as a separate component with their own ledger, remittance date and refund rule on early closure.
A foreclosure quote combines outstanding principal, accrued interest to the closure date, unpaid penal charges, any rebate and the insurance refund. Show each line, because borrowers query every one.
Freeze the quote with a validity date. A quote valid for five days must reproduce the same total on day five, even if rules were edited on day three.
Test the model before real loans go in
Build ten sample loans by hand in a spreadsheet, covering each method, a prepayment, a missed instalment and a closure. Run the same cases through the system. Every instalment, every day of accrual and every rounding must match.
Rounding is where systems drift. Decide whether rounding applies to each instalment or only the last, and fix the rule.
Keep the sample set and rerun it whenever a rule changes. Legal and regulatory terms differ by country, so have your compliance adviser confirm the rules you store.
Loan schedule test sheet
Ten sample loans sit in rows on one worksheet. Columns hold method, rate, day count, tenure, prepayment amount and date, missed instalment, expected schedule total and expected foreclosure quote. A final column records whether the system matches the hand calculation.
Open a blank worksheet to printQuestions owners ask
Why does a flat rate cost more than it looks?
Interest is charged on the full original principal even as it is repaid. The effective cost per unit of outstanding balance is therefore higher than the same quoted rate on a reducing balance.
Should one loan system hold all three methods?
Yes, if your products use them. Store the method per product, and test each with the same sample cases so a change to one does not alter another.
How do we handle a payment received on a holiday?
Store a rule for payment dating and a holiday calendar. The receipt date, the value date and the accrual stop date should be separate fields.
Who approves a change to penal charge rules?
A named senior role, with the change logged and effective-dated. Old loans keep the rule they were sanctioned under unless the agreement says otherwise.