Viewpoints on interest -- Habitat for Humanity Int'l 1

Viewpoints on interest

Editor’s note:
As Habitat for Humanity begins to partner with microfinance institutions, many of which charge interest rates in excess of commercial bank rates, what should our stance be on charging interest? The new sustainability policy gives the responsibility to each national organization or affiliate as they search for the right balance between subsidy and sustainability. Finance experts in Asia/Pacific, who have been struggling with this issue, were asked to comment on a series of questions. Here are their responses, which merely reflect their personal opinions and not any HFH policy:

Jay Evans, senior specialist in International Housing Finance, HFH Latin America and the Caribbean

Discuss the concept of charging interest, often above commercial bank rates, to the poor.

Charging interest marginally above the commercial rates is acceptable for Habitat, if the household income and expenditure profile of the target group can bear it and the rate is not usurious, as defined by local banking law. However, HFH must explain its decision to stakeholders and donors, especially if the decision is to charge a rate above commercial banks as might be the case in a partnership with a microfinance institution.

Are there differences between micro-enterprise loans and housing loans?

Housing is different from micro-enterprise. In fact, it is a much lower-risk loan if structured properly. The main difference is that housing does not generate income, even though some income can be generated as a result of house improvements that enhance an existing micro-enterprise operating out of the home.

Trying to squeeze housing into a micro-enterprise lending format is not the best path to follow. Housing loans are generally longer term, therefore the financing needs to be from long-term sources. Micro-enterprise loans are financed from shorter-term capital. Some of the more robust housing finance systems in the world, including Denmark and the United States, treat housing very differently from traditional business loans. They are also financed differently—for example, the use of bonds in the case of Denmark.

The long-term solution is to address the primary market barriers, like land tenure. However, in the short term, our main objective should be to bring down the cost of lending to the poor by reducing risk. In other words, we should be coming up with innovative ways to hedge risk, especially in volatile markets. Habitat can and should be part of the process of creating hybrid guarantees that reduce the overall cost of financing housing for the poor.

What should be considered in deciding on an interest rate?

In determining the appropriate interest rate for Habitat loans, we should consider the following:

  • The target population
  • Subsidies that are available or that will be used
  • The family income/expenditure profile
  • The cost of administering the loan
  • The local market and MFI rates
  • The interest rate tolerance of the Habitat national organization

Rajan Samuel, senior finance consultant, Housing Microfinance, HFH Asia/Pacific

Discuss the concept of charging interest, often above commercial bank rates, to the poor.

An estimated 500 million of the “non-bankable” have access to credit and other services through microfinance institutions. Nevertheless, another 2 billion people are still left out of the informal finance sector. Our ability to be sustainable is closely linked to our effectiveness in reaching out to the billions that don’t have access to any other type of credit. In order to promote sustainable poverty housing programs, we need to have a strategy to absorb all related costs and risks. The goal is always not to make money from the poor but to ensure that our housing products are “affordable” and “attractive” to our target population.

Are there differences between micro-enterprise loans and housing loans?

There is a fundamental difference between a productive (business) loan and a consumptive (housing) loan, both in approach and methodology. If we look at the MFI sector, very few are offering a “stand alone” housing product, but there are many opportunities for composite credit in combination with productive loans. Here we have a huge responsibility in not only educating the practitioners and stakeholders, but also to build and promote a viable business model for housing micro-credit.

What should be considered in deciding on an interest rate?

In deciding on the appropriate interest rate, Habitat programs should determine the cost of lending and servicing the loan as well as how it will finance the deficit or loss by following these steps:

  • Step 1: Develop the pricing structure and determine the required portfolio yield. This yield should correlate with the proposed interest and fee structure, regardless of the size of the loan portfolio.
  • Step 2: Depending on the sources of funds—whether from donations, debt recovery or equity—decide on the cost of funds or capital.
  • Step 3: Estimate the operating cost.
  • Step 4: Make provision for inflation.
  • Step 5: Make provision for capitalization.

We have a bold vision. God has given us the resources—physical, financial and human—to make a difference and empower communities. Are we ready to move ahead?

Peter Selvarajan, national director, HFH India

Discuss the concept of charging interest, often above commercial bank rates, to the poor.

When the non-poor in India are charged only 9 percent to 10 percent, I cannot see the justification for charging the poor interest rates of 27 percent to 39 percent. I realize that research indicates that the poor are “ready to pay,” “grateful” and “less sensitive to price”; however, this line of reasoning is only an exploitation of the fact that they have little choice and the source of comparison is with even more avaricious moneylenders who victimize the poor. Our comparison should be with the commercial home-lending rates of interest, which are highly profitable, even at low interest rates.

Are there differences between micro-enterprise loans and housing loans?

Commercial loans are not the same as housing loans, but the microfinance approach can be made to work. Even for microfinance loans, the government, the Reserve Bank of India or some other regulatory body should be lobbied to establish a ceiling in interest rates or an “X” percent point addition over the commercial interest rate for the non-poor. Lending banks need to bring in an averaging concept in cost of servicing customers and interest rates charged.

What should be considered in deciding on an interest rate?

Habitat’s decision on what to charge should be based on commercial interest rates to the non-poor, since commercial rates would cover all other aspects like costs, market, segment, etc. Once the rate is decided, based on the commercial interest rate, the duration of the loan should be adjusted so that the actual installment is tailored to the family’s monthly income and its normal, reasonable monthly expenditure for living.

The concept of average costing needs to be part of the home-lending equation. The overall cost of servicing customers across the home-loan continuum needs to be averaged out so that the not-so-poor home-loan customer to some extent subsidizes the poorer customer, covering risks and bad loans. HFH should not damage its brand by joining hands with any organization that is charging usurious rates of interest.

Gloria Tan, finance manager, Business Strategy and Analysis, HFH Asia/Pacific

Discuss the concept of charging interest, often above commercial bank rates, to the poor.

In order to have a more complete view of the Biblical principles behind charging interest, Habitat should consider scriptures from the New Testament, for example:

Matthew 25:27 “So you ought to have deposited my money with the bankers and at my coming I would have received back my own interest.”

Luke 19:23 “Why then did you not put my money in the bank that at my coming I might have collected it with interest?”

There should always be a cost to lending. From what I saw in Manila and the partnership that Habitat has with CCT, the housing and small business loan beneficiaries are very thankful for the microfinancing loan because no institution will give them a loan without collateral, and the moneylenders are loan sharks. The loans sustain their businesses and therefore enhance their living standards. They were not as concerned over the interest rates as the terms of repayment. CCT charges a flat interest rate of 18 percent. However, the repayments are worked out within the means of the borrower, and it is a win-win solution for both the borrower and the lender.

In CCT, the repayment rate is 99 percent. The mission of CCT is to transform lives via the provision of micro-credit to groups of people who have no access to loans or who would otherwise be at the mercy of loan sharks.

What should be considered in deciding on an interest rate?

In addressing these questions, we need to apply the new Sustainability Policy, regardless of the type of loan. A careful credit analysis of all types of loans needs to be made before any loan disbursements. The expense lines to be included in the calculation of the interest rate can be discussed and debated, however. Quite often, an analysis of the expense lines reveals both inefficiencies in management as well as good practices.

Our mission is to eradicate poverty through housing. To meet our goals, we may want to have a financial assistance scheme that will assist deserving home partners who cannot meet our credit criteria—for example, a grant similar to the housing program provided to tsunami victims. This grant program would be a separate exercise that is administered on a case-by-case basis, only to those who fall short of our credit criteria and are not able to access loans.