Search

# Phnom Penh Post - Micro-finance interest rates

## Micro-finance interest rates

Dear Editor,

Thank you for Caroline Green's article dealing with some of the serious problems

of micro-finance.

One aspect that requires further explanation is the understating of annual interest

rates that occurs when rates are quoted per month. A loan at interest of 5% a month

is not equivalent to an annual rate of 60% if the loan is repaid in monthly installments.

If I borrow \$120 for a year at 60%, at the end of the year I return the \$120, plus

60% x \$120 = \$72. I have bought the use of \$120 for a year, at a cost of \$72.

But if I borrow according to the "balloon approach" described in the article,

I am required to pay 5% of \$120, or \$6, at the end of each month, and to pay \$120

at the end of the year. This is clearly more disadvantageous to me, because the cost

of the loan is still \$72, but I do not obtain the use of \$120 for a full year.

To find the real annual interest rate in this case, we need to regard the \$6 monthly

payments as repayments of the principal. Then the final payment of \$120 consists

of two elements: \$72 in interest and the remaining \$48 of the principal that has

not yet been repaid.

In this example, I have obtained, not the use of \$120 for a year, but the use

of \$120 in the first month, the use of \$114 in the second month, the use of \$108

in the third month, and so on down to only \$54 in the twelfth month. Thus the real

amount of my loan during the year is not \$120, but the average of the 12 monthly

figures, which comes to \$87. Since I have paid \$72 to obtain \$87 for a year, my interest

rate is 72 divided by 87, or slightly less than 83%.

If the total repayment (\$120 + \$72) is made in equal monthly installments of \$16,

the annual interest rate is of course even higher. In this case, the borrower obtains

the use of an average of only \$32 for the year and pays interest of \$72, so the interest

rate is 225%. Even if the so-called monthly rate is reduced to 3%, a loan repaid

in this way has an annual interest rate of 95.6%.

- Allen Myers, Phnom Penh

## RECOMMENDED STORIES

• Breaking: PM says prominent human rights NGO ‘must close’

Prime Minister Hun Sen has instructed the Interior Ministry to investigate the Cambodian Center for Human Rights (CCHR) and potentially close it “because they follow foreigners”, appearing to link the rights group to the opposition Cambodia National Rescue Party's purported “revolution”. The CNRP - the