Calculating loan payment instalments

Before you take a bank loan, learn to calculate monthly payments, writes ANTONY NGATIA

First you get a phone call. The caller sounds confident, as if they know you personally. "My name is Joseph, I’m calling from Bank X. We have a new product suitable for you," the caller says.

A week later, a smart, suave young man and woman show up at your workplace. They are bank sales executives promoting their bank’s latest product.

Interest rates have gone down, they say, and interest calculation is on reducing balance. In fact, the loan payment schedule papers they generously dish out seem to suggest so.

There are many methods banks use to calculate interest rates, so before borrowing ask your banker which method applies to your loan and compare it with others . [PHOTO: COURTESY]

Then you are handed the application forms to have a look. "You can fill them now," they suggest.

Probably you don’t realise you have fallen for the selling gimmicks most banks use today to lure people to take the so-called ‘cheap loans’.

This is not just the story of Petronila Kathambi, a middle aged single mother of two and a civil servant.

But this is the reason why thousands of Kenyans take bank loans — for development and other personal needs — because they are told interest rates are low, and that payment is on a reducing balance.

The salaried and those self-employed are going for loans from banks without bothering on how the amount they pay every month is calculated.

Peter Makau, 43, a teacher in Embu believes banks hide some details from customers.

"I took an unsecured loan from a multinational bank to buy a plot. After paying the entire amount as per the agreement and schedule, I was surprised to be told I had Sh30,000 outstanding . I thought there was an error somewhere."

Upon inquiries, he was informed there wasn’t any erroneous billing by the bank. The charges stemmed from a two-month delay by his employer to release cheques to the bank, yet deductions from his pay had been effected.

EXTRA CHARGES

Wilson Kenyatta, a loans officer in a Nairobi bank corroborates that banks can levy charges a customer may not be privy to. "Extra charges arise when in the course of the loan payment, the person or entity remitting money to the bank, for instance the employer, delays to do so and bank levies interest and penalities.

Susan Munge, 38, a house keeper in a local public university felt cheated, too.

"I borrowed Sh200,000 repayable in three years at an interest rate of 15 per cent. With about Sh7,500 monthly deductions, I reckoned I would have paid Sh22,000 by the third month. "When I went to inquire about payments, I was shocked to learn the principal amount had barely reduced by a few thousands, the three month’s deductions notwithstanding."

Financial experts advise that before signing on the dotted line, reading the fine print is important. Not long ago, banks were widely accused by customers of being secretive with regard to the charges on loans and how they calculate interest.

In October 2008, a survey by Financial Sector Deepening Kenya showed most respondents admitted they could not understand the fees and charges on loans. The survey sought to establish how banks charges are calculated so that they could do their own calculations and compare between products.

EVERY MONTH

According to Evaline Mwamburi, 39, a banking lecturer in Nairobi, it is important that customers know how banks arrive at the amount they pay every month.

Banks use different methods to calculate interest and payment installments. A number of approaches are used depending on the loan type and duration.

Simple interest , compound interest, flat rate, and reducing balance are some of the popular methods.

The reducing balance method seems to be popular with Kenyan banks. The method calculates the interest payable based on the principal balance outstanding at each time interval and as capital amount owing is paid and decreases, so does the interest change. As the loan matures, a single portion of the loan payment money significantly reduces the principal figure.

What of the traditional amortisation schedule used as the basis of showing how the loan is to be repaid?

I posed this question to Silvanus Nyingi, a loan executive.

"I won’t say they aren’t used perse, but the fact is that most banks use a combination of different approaches to come up with interest and final payment figure. Armotisation is commonly used for business loans," he says.

Armotisation is the process of paying off a debt over time through regular or periodic payments. In amortisation, a portion of each payment goes towards interest while remaining amount is applied towards the principal. This explains why, initially a bank loan appears not to be reducing within the first few years despite one paying each month as happened to Ms Munge.

John Kihanda, an accountant explains that, once you obtain a loan to be paid say for five years, the first two years, according to the amortisation schedule, could be spent offsetting the loan’s interest as opposed to the principal.

Then after some time one will see a significant reduction in the borrowed amount once the principal starts to be reduced.

amount charged

"A loan has two components; the interest and the principal. The principal is the amount of money being loaned while the interest is the amount charged for lending the money. The interest is like a ‘user fee’ which the borrower pays to use the lender’s money," he says.

But interest is not the only payment a creditor has to pay. A bank loan also comes with a motley of fees such as application fee, risk premium, negotiation and commitment fees.