The Challenge of Understanding Pricing of Micro-loans
This paper uses the example of Compartamos, a Mexican MFI, to explain interest rate calculation and pricing system of microloans.
The IPO of Compartamos, Latin Americas largest MFI in 2007 raised a discussion on true interest rates, and the rates Compartamos charged its clients. The MFI made enormous profits while charging interests of over 100 percent. Most other MFIs in Mexico follow a similar pricing system. The paper uses numerical examples and calculations to illustrate the following aspects of interest rates and loan pricing:
- Difference between annual percentage rate (APR) and effective interest rate (EIR) methods in microfinance pricing;
- Pricing calculations using APR;
- Calculating monthly and annual interest rates;
- Flat interest rate method used by Compartamos;
- Clarity on number of weeks in a month;
- Commission fees and taxes;
- Impact of compulsory savings on APR;
- Implication of APR figures for the client.
The paper states that confusion regarding microfinance prices leads to poor consumer choices. This indicates a critical need for transparency and public awareness regarding the true cost of borrowing.