The three things you must know about your loan
The Sunday Nation
Nairobi,
31 July 2011
Money is a hot subject. Every month I get at least one question from a reader who is either worried about the amount charged by a lender or the returns earned from an investment. What I find amazing, nay, shocking, is that many people have signed up on loans and they don’t know the key terms of the agreement, namely, how much was borrowed, the interest rate and the duration.
Here is an example from a person who shall remain anonymous: “I took a bank loan of Sh350,000 in September 2008 and when they calculated their interests it amounted Sh680,000. They made deductions until June 2010 when I applied for some more money because I had emergency.
“By then the balance [on the first loan] was Sh345,000. I was told to clear this before I can get the additional Sh270,000, but I did not have that cash. So I was given an option of taking atop-up. I qualified to take Sh410,000 minus Sh270,000 so was given Sh137,000. The following month I received my statement and the total loan balance was over Sh800,000. Please help me; they have deducted Sh11,071 every month for the last six years.”
When I got this email, I asked the reader to tell me the interest rate applied and the duration for both loans (the initial one and the top-up) and the reply shocked me: “I don’t have all that information with me, but I will ask the bank to supply me with it at a cost. I will forward to you immediately I have it”! Three weeks down the line, I still haven’t received the details.
Now those figures don’t quite add up: If the reader qualified for a Sh410,000 top up and the balance on the initial loan was Sh345,000, he should have been given Sh65,000 it is not the Sh137,000.
Secondly, it is not clear whether the Sh680,000 amount is interest alone or interest plus principle. However, I will assume that it is both. Thus the interest part comes to Sh330,000. Furthermore, from the numbers given, it seems to me that this was a five-year loan calculated using the simple interest technique.
In this method of calculation, the interest is calculated on the full amount of the loan for the whole duration and the added to the principle amount. The total is then divided by the number of instalments. Even though the calculation seems easy, it actually results with a much higher interest charge than the so-called reducing balance technique.
Now, if we divide the Sh680,000 total amount as at September 2008 by the Sh11,000 instalment, the answer is about 61. After accounting for the rounding of numbers, it is reasonable to expect that the period was 60 months; that is, five years.
To get the interest rate, we simply divide the interest figure (Sh330,000) by five years to get the annual amount. This comes to Sh66,000. Then we divide this by the principle (Sh350,000). The answer is about 19 percent – that sound about right for the market at the time – 2008.
But what about the Sh800,000 balance? Well, I suspect that the same method was applied. He signed for a new loan of Sh410,000 on the same terms (19 per cent interest for five years). If you do the math, you will see that it comes to about Sh800,000.
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