How Interest Rates Work on Loans in Kenya: Complete Guide
Master loan interest calculations. Understand flat rates, reducing balance, APR, and how banks determine your rate. Make informed borrowing decisions.
Understanding Interest Rates: The Basics
Interest is the cost of borrowing money - what you pay the lender for using their funds. In Kenya, interest rates vary widely from 6% (government loans) to over 100% APR (some mobile loans). Understanding how interest is calculated helps you compare loans accurately and avoid paying more than necessary.
Bank Loans
13-18%
Per annum (yearly)
Mobile Loans
3-15%
Per month (30 days)
Government Loans
6-9%
Per annum (yearly)
Types of Interest Rate Calculation Methods
1. Flat Rate Interest
Flat rate calculates interest on the original principal amount throughout the entire loan period, regardless of how much you've repaid. This method is simpler but results in higher total interest costs.
How It Works:
Interest = Principal × Rate × Time
The interest for the entire period is calculated upfront and divided equally across all monthly payments.
Example: Flat Rate Calculation
Loan Amount: KES 100,000
Interest Rate: 10% per annum (flat)
Loan Period: 2 years (24 months)
Total Interest: 100,000 × 10% × 2 = KES 20,000
Total Repayment: 100,000 + 20,000 = KES 120,000
Monthly Payment: 120,000 ÷ 24 = KES 5,000
2. Reducing Balance (Diminishing Balance)
Reducing balance calculates interest only on the outstanding principal. As you make payments and reduce the principal, the interest charged also decreases. This is the most common method used by Kenyan banks and is significantly cheaper than flat rate.
How It Works:
Interest each month = Outstanding Balance × (Annual Rate ÷ 12)
Each payment reduces the principal, so next month's interest is calculated on a smaller balance.
Example: Reducing Balance Calculation
Loan Amount: KES 100,000
Interest Rate: 10% per annum (reducing balance)
Loan Period: 2 years (24 months)
Monthly Interest Rate: 10% ÷ 12 = 0.833%
Monthly Payment (EMI): KES 4,614
Total Repayment: 4,614 × 24 = KES 110,736
Total Interest: 110,736 - 100,000 = KES 10,736
Savings vs Flat Rate: KES 9,264 (46% less interest!)
Month-by-Month Breakdown (First 3 Months):
| Month | Balance | Interest | Principal | Payment |
|---|---|---|---|---|
| 1 | 100,000 | 833 | 3,781 | 4,614 |
| 2 | 96,219 | 802 | 3,812 | 4,614 |
| 3 | 92,407 | 770 | 3,844 | 4,614 |
Notice how interest decreases each month as the balance reduces.
⚠️ Critical: Always Ask Which Method Is Used!
Some lenders advertise "10% interest" without specifying flat or reducing balance. A 10% flat rate loan costs almost DOUBLE a 10% reducing balance loan. Always clarify before signing.
Annual Percentage Rate (APR) Explained
APR represents the true cost of a loan, including both interest and all mandatory fees. It's the most accurate way to compare different loan offers.
What APR Includes:
- ✓Interest charges - The nominal interest rate
- ✓Processing/Arrangement fees - Typically 1-4% of loan amount
- ✓Mandatory insurance - Loan protection insurance premiums
- ✓Other mandatory charges - Legal fees, appraisal fees for secured loans
Example: Calculating True APR
Advertised: "Personal Loan at 14% p.a."
Loan Amount: KES 200,000
Nominal Interest: 14% per annum
Processing Fee: 2.5% = KES 5,000
Insurance: 1% annually = KES 2,000/year
Tenure: 2 years
Interest Cost: ~KES 30,000 (reducing balance)
Processing Fee: KES 5,000
Insurance (2 years): KES 4,000
Total Cost: KES 39,000
Effective APR: ~17.2% (not 14%!)
Monthly Rate vs Annual Rate
Mobile loans often advertise monthly rates which seem low but translate to very high annual rates:
Note: Note: Simple multiplication (×12) gives rough APR. Actual APR with compounding is slightly higher.