How lenders cheat borrowers on interest rates
The Sunday Nation
Nairobi,
29 November 2015
Peter Kariuki wrote
in seeking an opinion on a loan he took from the Ecumenical Church Loan
Fund (ECLOF). In his initial email, he stated that the loan amount was
Sh200,000 payable over a period of 24 months at 18 percent interest per
annum. He went on to say that he has been paying Sh16,000 monthly and
was expecting to make the final payment this month – November 2015.
Peter was concerned
that at a total of Sh384,000, the repayment was too high – it is almost
double the amount borrowed. I also couldn’t believe it since my
calculations showed that he should have been paying just under Sh10,000
per month.
So, I asked Peter to
request the lender to explain clearly how they were calculating the
installments. He did better and sent me the loan contract document that
he signed and, after reading it, I was shocked.
It turns out that the
loan amount was Sh269,000 payable over 24 months. The shocking part was
how the interest (ECLOF calls it “service charge”) is calculated. The
document says, “Service charge shall accrue daily and shall be payable
with principle in 24 monthly installments”.
It goes further to
say that “the borrower shall pay service charge to ECLOF at a
flat rate of 18 per cent per
annum. Finally, the document gives the monthly installment payable as
Sh15,907 – this is the figure that Peter had justifiably rounded off to
Sh16,000.
When a lender talks
about a “flat rate”, they mean
that the interest will be calculated for the full amount AND over the
full period of the loan. That is, in Peter’s case, the lender would
calculate 18 per cent of Sh269,000 for 2 years and then divide the
result by 24 months.
Now 18 per cent of
Sh269,000 is Sh48,420; so, for two years the total interest comes to
Sh96,840; adding this to the principle amount yields Sh365,840. Finally,
we divide this by 24 months and get Sh15,243. Our answer is
significantly different from the Sh15,907 that Peter has been paying.
The statement that
“service charge shall accrue daily” reveals the hidden factor. The way I
understand it is that we shouldn’t treat the 18 per cent as simple
interest. Instead we should compound it on a daily basis.
To do this, we divide
18 per cent (or 0.18) by 365 days: the answer is approximately 0.05 per
cent (0.0005). Then we add one to get 1.0005 and raise this result by
the power of 730 days (two years). The answer is 1.433.
Finally, we multiply
this result by the amount borrowed (Sh269,000): the answer is Sh385,531.
This is the total of interest and principle that the borrower should pay
So, we divide it by 24 months to get the monthly installments. The
result is Sh16,064.
In other words,
according my calculation, Peter has actually been paying less than what
is due! Nevertheless, I think this lender (ECLOF) is dishonest and
that’s shameful for a religious institution. They have used every trick
in the book to deceive borrowers that the interest is competitive
(comparable to commercial banks) yet it is more than double the market
rate!
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