Faulu and its flat interest rates (long read)

Business
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So you have probably seen or heard numerous adverts about Faulu and their flat interest rates.

…Well Mr. Mungai Kihanya tries to explain why these flat interest rates are not really cheap.

This is a control C+V of his articles for the past 2 Sundays.

Part 1: Sunday November 29:

Peter Kariuki sought my 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 per cent
interest per annum. He said that he
has been paying Sh16,000 monthly
and was expecting to make the final
payment this month.

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.

SERVICE CHARGES

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
principal 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 18pc of Sh269,000 for 2
years and then divide by 24 months.

Now 18pc 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 18pc (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 is
dishonest.

They have told borrowers
that the interest is competitive
(comparable to commercial banks)
yet it is more than double the market
rate!

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Part 2. Sunday 06 December

LAST WEEK WE looked at the case of
Peter Kariuki who borrowed some
Sh269,000 from the Ecumenical Church
Loan Fund Kenya (ECLOF) 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 “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.

FAIR RATE

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 increase 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 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 36 per
cent, he would have thought about it long
and hard before signing on the dotted
line!

That is why I concluded that ECLOF
was perhaps not altogether forthright in
this particular deal.

4 Likes
3

Sasa Faulu imekujia wapi ama did i miss something?? .

1 Like
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Faulu is the bank most famous for Flat interest rates. It’s ever been asked here by someone what is hidden in it.

5

thanks bro.
ebu nipee link to kihanyas website.
this guy explains numbers to the layman just as kidinyi would give you directions to sabina joy

6

jaribu mungaikihanya.com . But mimi I religiously read his articles on Sunday Nation. He’s very good and makes complex things appear simple.

1 Like
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also do the same. wakiwa na caro(2nd page lifestyle) na mwalimu dre ndio wanafanya ninunue gazeti.
lakini mahali niko (in laikipia near samburu)hakuna gazeti.

1 Like
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Thanks okiya, this loan business I have never really understood completely and it’s very easy to lose track once you start payments

9

Ukitaka kuelewa mambo ya loan na usilose track, next time before you sign the dotted line do as follows:

  1. Open a blank MS excel workbook.
  2. On the top left, click on the file tab
  3. From the scroll down options, select new
  4. On your right, from the available templates, select loan armotisation schedule
  5. Enter all the details in the excel schedule. It will easily compute for you everything including principal and interest to pay every month and the outstanding loan amount at the end of this month.
  6. Print out the excel sheet and ask the bank to verify that your computations are correct. If they refuse jua hapo kuna T&C that unafichwa.
8 Likes
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Very eye opening:rolleyes:

11

that Kihanya guy does he eat numbers for breakfast?