Hi all,
Last week I was training a group of microfinance practitioners and the concept of transparency and interest rates came up. I immediately thought of MFTransparency (of which I was a founding board member) and the interest rate calculation tool that’s been used thousands of times to calculate APR and EIR of products worldwide. But I wondered how these numbers are explained to borrowers. I’m sure that the borrowers can be instructed, “the MFI with the lowest APR or EIR has the lowest borrowing cost”, and that’s pretty simple and maybe I should leave it at that. (Some borrowers chose to go with a more expensive source of funds because it may prove easier to get, to repay, or maybe they don’t want to join a group, etc., but we’ll leave that aside for the moment.)
However I was curious if, to perhaps make it more simple for borrowers to understand, if the MFI could tell the client, “If you get this loan and pay it off as scheduled, then get another loan immediately thereafter so as to complete one year of borrowing with us, your interest and fees and other charges will be 75 (pesos) for the 300 (peso) loan.” You and me would pull out our calculators and compute the rate of 25%. I was thinking, though, that this doesn’t take into account the difference from a “balloon” or “bullet” or “principal paid at the end of term” loan and a declining balance loan where, on average, ½ of the loan is outstanding at any one point in time (I know it’s a bit more than that, but for simplicity purposes, let’s say it’s ½). So the client would need to be instructed about this and be told that they are only going to have access to ½ of the capital, at any one point in time, so it’s more like a 150 peso loan. (Which increases the stated rate to 50% in this example). In other words the statement above would need to be revised to say, “If you get this loan and pay it off as scheduled, then get another loan immediately thereafter so as to complete one year of borrowing with us, your interest and fees and other charges will be 75 (pesos) for the 300 (peso) loan. However we’re asking you to pay off a portion of the loan amount with each payment so on average you’re only able to use 150 (pesos) of the 300 (pesos). You should compare the cost of 75 (pesos) with a 150 (peso) loan with other MFIs to determine the lowest borrowing cost.”
So my question(s) to the group is, “Have you seen interest explained in this way to a borrower?” And then feel free to tell me if you think it’s a good idea or not to try this out. Private or public critique is welcome.
Thanks for your comments in advance,
-howard
Howard Brady
President & CEO – MFI Resources
MFP Moderator
hbrady@mfiresources.org
Posted by: "Howard Brady" <hbrady@mfiresources.org>
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