The terms "fixed rate" and "flat rate" sound interchangeable in nature but, in fact, are not. These are terms that express constancy of price and percentage from the separate viewpoints of consumers and producers. The term "fixed rate" is associated with the yield or accrual on interest-bearing items, such as bonds and loans. By contrast, "flat rate" describes a pricing model used by producers with respect to volume.
A fixed rate, or fixed interest rate, pertains to instruments like mortgages, bonds, certificates of deposit or another financial arrangement in which a lending party is compensated with interest by a borrower. A fixed rate is simply an interest rate that remains the same throughout the life of the instrument to which it has been applied. For example, if a bond with a term to maturity of five years from the date of issue has a fixed interest rate of 2 percent, the bond will accrue 2 percent per year for each of the five years until it matures.
Read More: Disadvantages & Advantages of a Fixed-Rate Mortgage
Opposite of Fixed Rate
To help better illustrate the nature of a fixed rate, consider its opposite: the variable rate. Items that accrue interest at a variable rate experience periodic fluctuations in interest. The rate on such items is adjusted each payment cycle. In the case of a bond, the rate is adjusted according to the change in some benchmark rate, such as the prime rate. For instance, if a quarterly-paying bond carries an interest rate of 2 percent on March 31 and the benchmark rate is one-tenth of a percentage point higher on June 30, the bond's interest rate will be adjusted upward to 2.1 percent.
A flat rate is a method used by producers for pricing services relating to some product, such as financial assets in the case of an investment house. A flat rate is a price rather than a percentage and is typically applied where variable sales volume is concerned. For instance, an investment broker may charge clients a flat rate of $50 for giving investment advice, whether they purchase $10 or $10,000 in securities.
The greatest advantage of a fixed rate is that it provides a level of predictability for more risk-averse investors, in terms of debt securities called fixed-income items. For instance, the consistent periodic interest (coupon) payments of a bond come directly from a fixed, unchanging interest rate. A flat rate provides some measure of protection for producers, as it ensures the existence of a revenue floor in a business model in which most revenue is based on the high-volume sale of goods.
Despite the stability a fixed rate might provide in many instances, it can work to the disadvantage of the party concerned should the general level of interest rates rise. Under such circumstances, the market value of fixed-rate items, like bonds, declines, and this can create a hardship for holders who wish or need to sell their holdings. Likewise, a flat-rate service fee may work to a company's disadvantage should an unusual level of service need to be performed for which little or no sales volume is produced. An example would be a broker spending several hours advising a client who purchases no securities.
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- Federal Reserve Bank of St. Louis. "Bank Prime Loan Rate (DPRIME)." Accessed March 17, 2020.
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- Bureau of Consumer Financial Protection. "The Consumer Credit Card Market, August 2019," Page 12. Accessed March 18, 2020.
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- Consumer Financial Protection Bureau. "When Can My Credit Card Company Increase My Interest Rate? What Can I Do to Get the Rate Back Down?" Accessed March 18, 2020.
Nicholas B. Sisson holds a B.A. in economics from Ithaca College and a certificate in technical communication from J.B.S. Technical Communications, Ltd. Working in investment operations, Sisson participated in an initiative to revise and rewrite his group's procedure manual. More recently, Sisson created definitions of financial terms for the glossary of a major financial website. He has been writing since 2008.