Why might a lender choose to use the sum of the balances method?

The sum of the balances method is advantageous for lenders primarily because it allows them to enhance the amount of money collected in early payments. This method involves calculating interest based on the total outstanding balance of the loan, which can lead to higher interest payments in the initial stages of the loan term. By focusing on the sum of the balances at the time payments are made, lenders can maximize their cash inflow upfront, effectively improving their immediate financial position.

This method is particularly beneficial in situations where borrowers may pay down their loans more quickly, as it ensures that the lender receives interest based on the total balance, thus capturing more revenue during the time the principal is still high. This strategy can be an effective means to manage cash flow for the lender, especially in a lending environment where early repayment is common.