# Premium Loan Penalties

Premium Loan Penalties are employed when a premium borrower's LTV ratio exceeds their contractual Liquidation LTV and they are liquidated. The nature of this fee is primarily to incentivize thoughtful and risk-conscious use of premium markets. The fee is broken down into two parts:

the Premium Loan Liquidation Fee (PLLF),

and the Premium Debt Penalty Rate (PDRR).

## Premium Loan Liquidation Fee

The Premium Loan Liquidation Fee (PLLF) is a flat fee applied punctually to the collateral value before liquidation, when the liquidation of a premium borrower's position is executed by a liquidator. The flat fee is fixed at 10% for all premium borrowers. Because the DPF cannot be recovered through the liquidation, it is accounted for as recoverable debt and is added to any debt resulting from the liquidation.

Leaning on the example in the Debt & Debt Tokens section, Borrower A was awarded a 100% LLTV in a FLOW-USDf market and their collateral position was equal to 2,000,000 FLOW worth $1,000,000. When the borrower defaulted, their FLOW collateral was fully liquidated. Because the Liquidator Incentive Factor (LIF) of 2% was applied and the collateral was sold at a 2% discount, the resulting recoverable debt, not including the DPF amounts to $40,000.

The DPF is levied on the original collateral value of 2,000,000 FLOW equal to $1,000,000. As a result, an additional $100,000 is added to the debt, meaning that the total value of recoverable debt for Borrower A is $140,000.

## Premium Debt Penalty Rate

The Premium Debt Penalty Rate (PDRR) is a punitive interest rate multiplier applied to recoverable debt with the goal of incentivizing a premium borrower in default to make lenders whole as quickly as possible. Paying off recoverable debt early ensures that borrowers in default limit the accelerative growth of their liability due to compound interest resulting from the PDRR.

The function used by the protocol to calculate the value of recoverable debt is based on a standard compound interest function.

Where:

A is the amount of money accumulated after n periods, including interest,

P is the principal amount (the initial amount of the loan),

r is the annual nominal interest rate (not in percentage form),

n is the number of epochs (roughly 1 week on the Flow blockchain),

and m is the PDRR, currently fixed at 3.

Using the example above, where Borrower A owes $140,000 to lenders, the price of FLOW remains stable at $0.50 per 1 FLOW, and the average interest rate for the period is 4%, the resulting value after at the expiration of the 48-hour grace period would be:

If the recoverable debt goes unpaid for 1 month under these same conditions, the result would be far more punitive:

Last updated