Presentation is loading. Please wait.

Presentation is loading. Please wait.

Effective Interest Rate. “Is your microfinance product correctly priced?”

Similar presentations


Presentation on theme: "Effective Interest Rate. “Is your microfinance product correctly priced?”"— Presentation transcript:

1 Effective Interest Rate

2 “Is your microfinance product correctly priced?”

3 What is an “Effective Interest Rate”? Refers to the inclusion of all direct financial costs of a loan in one interest rate. Useful in determining whether the conditions of a loan make it more, or less, expensive for the borrower than another loan and whether changes in pricing policies have any effect

4 Factors that influence the Effective Interest Rate Nominal Interest Rate Method of interest calculation (declining balance or flat rate) Payment of interest (deducted from the loan or over the term of loan) Service Fees Contribution to guarantee, insurance or group fund Compulsory savings or compensating balances and corresponding interest paid to the borrower. Payment Frequency Loan Term Loan Amount

5 Methods of Calculating Effective Rate Estimation Method Internal Rate of Return

6 Estimation Method Effective Amount paid in interest & fees Interest Rate = Average Loan Balance Where: Ave.Loan Balance = (Sum of loan balances) Number of Payments * Formula does not require the use of a financial calculator or computerized spreadsheet – the Effective Interest Rate can be computed manually.

7 Effective Rate Estimate : Effective Rate Estimate : Declining Balance Where : Loan Amount: P1,000, 12 monthly payments, 20% p.a. interest, 3% SC Effective Rate = (111.76 + 30) / (6,697.08/12) = 25.4% p.a. MonthPaymentsPrincipalInterestOutstanding Balance 0---1,000.00 192.6375.9616.67924.04 292.6377.2315.40846.79 392.6378.5214.21768.29 492.6379.8312.81688.46 592.6381.1611.48607.30 692.6382.5110.12524.79 792.6383.888.75440.91 892.6385.287.35355.63 992.6386.705.93268.93 1092.6388.154.49180.78 1192.6389.623.0291.16 1292.6391.161.530.00 TOTAL1,111.561,000.00111.766,697.08

8 Internal Rate of Return Method The Internal Rate of Return is defined as the specific interest rate by which the sequence of installments must be discounted to obtain an amount equal to the initial credit amount To determine the effective rate by calculating the IRR, the following loan variables are entered into a financial calculator or computer spreadsheet (e.g., Excel) PV = Present Value, or the net amount of cash disbursed to the borrower i =Interest rate, which must be expressed in same time units as n below n =Total number of installment payments PMT=Amount of each installment payment FV =Future value, or the amount remaining after full payment of the loan (zero except for loans with compulsory savings that are returned to the borrower)

9 Using Excel Worksheet to compute for Effective Interest Rate 1.Open an Excel worksheet. 2.Click the icon for FUNCTION (fx) 3.In the dialogue box, click FINANCIAL in the left column, then click RATE in the right column. 4.In the row named Nper, input the total number of installment payments. 5.In the row named Pmt, input the total amount of each installment payment, including the corresponding amount of contractual deposit. This amount should be negative. For example, if the total weekly installment is P500, the amount to be keyed in should be –500. 6.In the row named Pv, input the amount of loan proceeds, net of all deductions. 7.In the row named Fv, input the total amount of the borrower’s contractual deposit at the end of loan cycle. 8.The formula result is the Internal Rate of Return (IRR) and is displayed at the bottom of the box. Click OK to close the box.

10 Using Excel Worksheet to compute for Effective Interest Rate 9.To compute the Annual Effective Rate, use the formula: (1 + IRR)n - 1 x 100 Where: n = total number of installments in a year (i.e. 12 if payments are in monthly installments, 24 if in bi-monthly installments, 52 if in weekly installments, and 360 if in daily installments) 10.To compute for the term (1 + IRR)n, input the sum of (1 + IRR), then click the icon for FUNCTION (fx), then click MATH & TRIG on the left column, and POWER on the right column. Click OK to close the box. 11.In the new box, input the sum of the term (1 + IRR) in the row named NUMBER, then input the value of n in the row named POWER. The formula result is your annual effective interest rate. Click OK to close the box.


Download ppt "Effective Interest Rate. “Is your microfinance product correctly priced?”"

Similar presentations


Ads by Google