"Flat" Interest Rates: Just Another Way to Swindle the Global Poor Using Your Tax and Charitable Dollars

Flat interest rates are the current controversy raging on the microfinance community listserv. This is a highly widespread and dubious practice in microfinance. Flat rates cost the borrower more than the standard declining interest rate – but the micro-enterprise owner is often in the dark about this reality. With flat interest rates, each month’s interest is charged on the original amount of the loan. Declining interest rates vary in that interest is charged according to how much of the original loan remains in the borrower’s hands, which shrinks as successive payments are made. Although common in microfinance, flat interest rates are not the banking standard in the developing world, so often when a microfinance institution quotes a 2% monthly interest rate to its customers, the actual rate of interest is much higher. How much higher depends on the term of the loan, but the actual rate can easily be twice as high.

Because clients are often illiterate and financially inexperienced (or too trusting of the local NGO), flat interest rates sound appealing. And in addition to the larger interest payments that come with flat rates, they are easier for microfinance institutions to calculate. For these reasons, flat interest rates have been seized upon, but at the expense of the unsuspecting borrower.

Bottom line: not only are customers deceived, but microfinance institutions that use the standard declining rate are at a significant disadvantage. Equally insidious, microfinance institutions quote these flat rates to donors who fall for the same trick as the micro-enterprise owners.

Not surprisingly, there are plenty of defenders of flat rates in the donor community. The reasons range: "German mortgages are written using flat rates too;" "a top microfinance institution in India, ICICI, uses flat rates;" "small microfinance institutions do not have the infrastructure to calculate declining rates." While all this may be true, it is a well-known fact in the microlending trenches that flat rates deceive customers. Of course, there are many examples of firms responsibly using flat rates, but that is not the point. The point is that your tax and charity dollars are often being used to gouge the global poor.

Additional Resources

1) US Agency for International Development (USAID): "Calculating Effective Interest Rates on Microcredit Loans."
2) Consultative Group to Assist the Poor (
CGAP): "Microcredit Interest Rates."3) Information from the Consultative Group to Assist the Poor (CGAP) regarding potential disparity between flat and declining interest rates in terms of annual return on loans

Similar Posts: