The Sunday Nation
Nairobi,
06 December 2015
Last week we looked at the case of Peter Kariuki who borrowed some Sh269,000 from ECLOF Kenya at 18 per cent “flat rate” per annum. At the end of the analysis, I mentioned that this is double what the banks would have charged. A few readers have asked for an explanation.
On the face of it, 18 per cent looks very competitive because that is slightly below the rate charged by many banks. However, there is a very big difference in the way banks do their calculation and how ECLOF does it.
Banks normally use what is referred to as “the reducing balance” method on monthly intervals. This means that at the beginning of every month, the bank looks at the total balance in your account (principle plus any outstanding interest) and calculates the interest on that amount.
If you regularly pay the correct amount, you will never have any outstanding interest. Most of the people who complain about too much interest on a bank loan will usually have missed some payments, or even under paid in some months.
ECLOF does two peculiar things: first it loads the interest for the full amount assuming that the borrower will keep the money for the full duration. Secondly; it compounds the interest on a daily basis while banks do it monthly.
These two things have the net effect of increasing the amount paid by a large margin. In Peter’s case, he ended up paying back a total of Sh381,768 (Sh15,907 monthly) while he had borrowed Sh269,000. Therefore, the interest amount was Sh381,768 minus Sh269,000; that is, Sh112,768.
If he had taken the loan from a bank and at the same interest rate, his monthly instalments would have been Sh13,430. So, at the end of two years, the total payment would come to Sh322,320. Now, if we subtract the principle sum (Sh269,000) from this, we find that the interest charged was Sh53,320.
In summary, ECLOF charges a total interest of Sh112,768 while the bank, using the same rate, would have charged Sh53,320 – less than half what Peter paid!
Of course, an argument can be made that Peter may not have qualified for a bank loan at 18 per cent; perhaps his risk profile is not very good. In that case, we can calculate equivalent bank rate for the Peter’s loan in order to decide whether it was fair.
The result is 36.17 per cent per annum. Was this a fair rate? Well, I don’t know Peter’s credit history and I am not a banker – I just crunch the numbers! But I am certain of one thing: if Peter was made an offer to borrow at 36pc, he would have thought about it long and hard before signing on the dotted line! That is why I concluded that ECLOF was not altogether forthright in this deal.
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