Comparison of Loan Payment Models Using Diminishing Balance Interest Rate

Lending and borrowing money are ancient practices with specific injunctions for dealing with the borrower given in the Bible. In modern times loans allow the borrower to acquire goods in advance while the lender earns profit through the interest charged. Interest-loaded loans may lead to overspending with financially disastrous consequence for the borrower. In this paper, two models of  loan payment, Equal Principal Payment (Model 1) and Equal Installment Payment (Model 2 are presented based on  diminishing balance interest rate. The simulated results of the models compared with data provided by a private credit cooperative showed Model 2 to be more realistic, the amount paid comparable with payment to the Credit Cooperative and easy to remember. The interest charged by the private cooperative fluctuated but in a declining pattern while the interest charged in the two models declined continuously, with lesser total interest charged but the difference is not significant. Understanding interest schemes for loan payments may mitigate the danger of financial disaster through overspending.

 

Keywords: Mathematical model, interest, equal installment payment, equal principal payment