The interest on loans is accrued on a daily basis, which allows you to charge your clients only for the days they actually used the loan amount.
So, for instance, if a member pays back before the due date, Kwara will display the exact interest amount that the client owes at that moment. Also, when a repayment is late, interest will keep being accumulated each day
The only calculation method in which interest is not accrued in Kwara is Fixed Flat. When using this method the interest will always reflect the amount that would be due on the due date, regardless of the actual payment date.
The interest rate source allows organizations to fix their interest rate to a standard - index - which is determined externally.
The Days in Year will determine how interest will be accrued.
Interest Calculation Methods
There are three different interest calculation methods you can choose from for your loan products:
- Declining Balance
- Declining Balance with Equal Installments
When creating a new loan product, you will need to choose one of these methods to be associated to that product and all the accounts created under it.
Next you can see how the repayment schedules would look like for each of the methods.
The loan details for every example are:
- Amount: 1000
- 4 installments
- Repayments are made every: 1 Month
- Interest Rate: 10%
- Interest Rate Frequency: Monthly
- Disbursement Date: 1/23/2011
- 365 days
This is the only method for which interest is not accrued over time. All interest and principal become due immediately upon disbursement and regardless the first repayment date.
The interest due depends only on the interest rate, principal amount and time between repayments.
Declining Balance methods reflect the actual cost of the loan more accurately than Flat methods as the interest is calculated on the outstanding balance.
The clients will then be paying interest only on the actual amount they still owe and not on the total amount as is the case with Flat methods.
In this case, as the client starts making repayments, the interest due will keep decreasing over the duration of the loan.
Declining Balance (equal installments)
Just like for the Declining Balance method, the interest is also calculated on the outstanding principal amount. The difference in this method is that the client will pay equal installments for the duration of the loan. This is achieved by increasing the amount of principal being repayed as the interest decreases, adding up to the same fixed amount for each installment.
Non equal installments due to rounding and first repayment date
In some situations it can happen that one of the installments is different than the others.
This can occur, for instance, when the time from disbursement until the first repayment date is longer than the time between each installment. In this case, there will be more interest accrued and less principal in the first installment and the remaining principal is added to the last or to the first installment - as defined in the product settings.
Capitalized Interest type is available for Dynamic Term Loans with Declining Balance interest calculation method and for Offset Loan with Declining Balance Equal installments interest calculation method. When this type of interest is used, the interest amount is capitalized into the principal balance and will be increased from one installment to another. On the schedule, the principal amount will be allocated on the last installment, previous installments having only the interest capitalized.
Accrue Late Interest
Normally, businesses have a legal right to charge interest on late payments, however, in some cases, for example, if you want to create a flexbile product which rewards customers for paying on time rather than penalises them for paying late, you may want to disable this option.
The Accrue Late Interest option is available for products using the Declining balance (Equal Installments) interest calculation and Reduce Number of Installments for pre-payment recalculation. This can be unchecked in order to NOT accrue and apply late interest for issued loans.
The feature covers all Payments methods (standard payments, balloon payments, and optimised payments) and is available via API 2.0 and the UI.
Interest Rate Source (Fixed or Indexed)
In Kwara you can set up two types of interest rate sources, via the "Interest Rate Source" setting of the product:
- Fixed - Some organizations choose to provide their customers with a fixed interest rate, which is used for the the entire lifetime of the loan.
- Indexed - Some organizations on the other hand, fix their interest rate to a standard rate which is determined by an external entity, such as a government, for instance.
Loans can then be set up to use either a fixed interest rate established by the organization or by an index rate which can vary over time and is determined by an external entity. In the latter case loans will need to be updated to reflect the new interest rate whenever it changes.
The frequency at which the interest rate should be reviewed is determined when creating a product and can be set on a daily, weekly or monthly basis. If there is a new rate when the review is made, then all loans using that source as an Index Interest Rate will be updated.
Consider a loan with the following terms:
- Loan Amount:$1000
- Interest:5% (index) + 2% (Spread)
- Monthly Installments
- Disbursal date:13.12.2011
- Interest Review:Monthly
Now suppose that on January 1, the Central Bank keeps the Index rate to 5% and on February 1 increases it to 6%.
The change will affect the loan's repayment schedule:
- First installment on 13.01.2012 - Interest: 7% (5% Index + 2% Spread)
- Second Installment on 13.02.2012 - Interest: (6% Index + 2% Spread)
Index Rate Floor and Ceiling
Some organizations apply a floor (min) or ceiling (max) to index interest rates as well. That is, that the combined index + spread cannot be less than or more than a predefined value. These limitations can be defined as part of the product configuration. For accounts using this product, when their interest rate is set up or updated they will not exceed the ceiling, if defined, and will not go below any defined floor.
Assume floor rate: 10% and ceiling rate = 20%
Index Interest RateSpreadActual Rate10 5 15 10 17 20 5 3 10
The Index rates are defined in Administrations under General Settings and can only be applied to non flat interest calculation methods, since for flat products, the interest amounts are fixed from the beginning and can not change.
Days in Year
You can choose from three different ways to accrue interest on a loan:
- Actual 365/Fixed is the method that calculates the interest daily by counting the number of days in the calendar and uses a fixed 365 year length.
- Actual/360 also computes the interest daily by counting the number of days in the calendar, but uses a fixed 360 year length.
- 30E/360 counts the days from the calendar, but also introduces some changes on the months with 31 and 28 days.
Particularities in the 30E/360 method
When using this method, when the month has 31 days, it will be considered as having 30. This implies that on the 31st of that month the number of accrued interest days will be the same as on the 30th.
The last day of February is treated as the 30th day of the month.
Also, the 30E/360 days in year method will compute the interest knowing that there is a maximum of 360 interest days in that year. So for instance, if a loan account has repayments paid yearly, the interest will be calculated for 360 days, instead of the actual number of days on the calendar.