The Barbados National Bank continues to distinguish itself as the leading financial institution in Barbados. The company’s Managing Director Robert Lehunte, is reporting a profit of 25.4 million dollars over the first half of its financial year. The bank’s retail sector led the way with 21.4 million dollars in profits, the Barbados Mortgage Finance Company Limited 2.3 million and BNB Finance and Trust 1.7 million. Mr. LeHunte says shareholders will continue to benefit handsomely from the company’s gains. Mr. Lehunte has described the next year as one for consolidation in which the bank will focus on implementing a new computer system, and on upgrading its branches.
BU recently received a note from a poster who wanted us to investigate why Barbados National Bank calculates interest on loans using a method called “add-on”. We must confess that it sounded like Greek to us and it explains why the note has been slipping down the list in the BU “inbox” for a few weeks. The piece BU did on the non-performing BNB Mutual Funds back on May 07, 2007 prompted the writer to email us.
First of all let us thank the writer for having the confidence in us to write on what is a quasi-technical matter. With topics such as this one, we have to make several inquiries, so we ask that BU readers to be patient with us given this constraint.
BU wish to congratulate BNB on the achievement of reaching #1 status in Barbados which is due it seems to their Trinidadian aggressive way of doing business in Barbados.
A Google of “add-on” interest calculation tossed-out several definitions, the one we like:
In this type of calculation, the interest costs are calculated by adding the total interest payable over the life of the loan to the original loan principal, which is the amount you wish to borrow. Therefore, your effective principal includes the interest rate due (hence ‘add-on’). Here’s a simple formula to calculate interest using this method:
Add-On Interest = Principal x Interest Rate x Number of Months in the loan / 12
The principal repayment due is computed by dividing the original principal into a number of months for payback according to the terms of the loan. The total fixed repayment is made up of the interest charges plus the principal repayment.
Here’s a simple example: You borrow $200,000 at 11 percent add-on interest for 2 years. Monthly payments are to be made. Total add-on interest = $200,000 x 11% x 24 / 12 = $44,000. This figure is added to the principal amount of $200,000 to get $244,000.
Your monthly repayments would be $244,000 / 24 = $10,166.67
Wow! That explanation was simple enough to understand.
The next step in our investigation was to determine what made the “add-on” method of calculating interest by BNB so offensive that it would upset our BU poster. Calls were made to the other banks to inquire how interest was calculated on loans. The outcome of the 20 minute exercise showed that BNB is the ONLY bank in Barbados which uses the “add-on” method of calculating interest.
A Google of the “reducing balance” interest methof of calculation tossed-out this definition:
Reducing Balance Method
In this repayment method, interest is calculated for each period by multiplying the agreed interest rate by the principal that’s remaining to be paid at that time. The difference between reducing balance and add-on is that interest is not charged on the principal that has already been repaid.
There are two ways of repaying your reducing balance loan: fixed principal payments and fixed total payments. In the first, the original principal is divided into equal monthly payment amounts according to the term of the loan. The initial interest amount is charged on the original principal and subsequent interest charges are computed on the balance of principal owing.
The total repayment reduces over the life of the loan. If you borrowed $200,000 at 21.5 percent per annum over 24 months, your total repayment amounts would vary from $11,867.58 per month to $8,480.59 by the end of the loan.
In the fixed total payment option, a calculation is used to determine how much the total repayment would be, given the interest rate and the term of the loan. The amount that is paid towards the principal would be computed by subtracting the interest amount due each month from the fixed repayment figure. Given the above example, you would pay about $10,300 every month to pay off the loan.
So far so good!
The two methods using the two examples appear to be easy enough to understand. The question which we had to answer next is why would the other banks in Barbados with the exception of the Barbados National Bank have switched from “add-on” to the “reducing balance” method.
In the USA it is mandatory that all loans advertised must show the Annual Percentage Return-commonly referred to as APR. This ensures that customers can compare the cost of a loan from different lending institutions using a standard approach. A more formal definition of APR:
The annual rate that is charged for borrowing, expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction.
BU was able to determine that there is no law in Barbados which forces a bank to offer one of the interest calculating method above the other. It seems from our investigation that it comes down to business ethics. In the two examples used, in example one if BNB were to advertise a loan at 11% (add-on) instead of 21% (reducing). To unsuspecting Barbadian borrower might view the BNB loan advertised at 11% as being cheaper. It is the method which the marketing people would prefer because most Barbadians do not take the time to calculate what is the “effective interest rate” on the loan or to read the special condition notice which maybe stated. In this example the add-on rate of 11% in comparable terms calculates to an effective rate of approximately 21%.
In the USA it is mandatory that lending agencies quote the “effective rate” when advertising add-on loans. In Barbados it is our understanding that the Fair Trading Commission require lending institutions to do the same but it is not police with any rigour and it is usually listed under the notice “special conditions apply”.
BU wishes to advise our concerned person that as an outcome to our investigation, which was a learning experience, they should calculate what the effective interest rate on the loan from BNB is and compare to what it would cost using the ‘reducing balance” if it was taken from another bank.
At the BU if we had to make the choice we would prefer a loan using the “reducing balance” simply because the customer has control of how much interest is finally paid. If we wanted to pay more than the minimum monthly payment or to repay the loan early to save interest, having an “add-on” loan would not be advantageous.
Barbados National Bank~Tell Us About Your Non-performing Mutual Funds
Website Used To Research Topic:
Reading above it is clear that BNB is making a huge gain at the borrower’s expense. My mortgage shows the interest amd principal payments each month side by side in a list, going from now up until the end of the loan. At first the interest is high becaue interest is on the full principal, but as time goes on and more principal is repaid the interest goes down.
At BNB the interest never goes down, no matter if you repay principal! If allowed to persist then we’ll all end up in this system soon as the banks gouge like the rest of the sectors. We need the FTC.
One would be well-advised to steer well clear of any bank that does “add-on”. It’s usurious. Why aren’t there banking regulations re this? Where is the media?
I think that you’ll find that vehicle lease payments are calculated using the “add-on” method. The advantage of leasing for a company is in tax savings, so the whole package, including tax savings, should be taken into acount when leasing a vehicle.
Actually I have a mortgage with BNB and a loan and both of them are reducing balance loans. I also know that late last year RBTT was running a promotion about lending up to five times your salary and that too was a loan on the basis of add-on. There are also a number of non-bank financial institutions who charge add-on interest equally some hire purchase companies do it too.
Concerned/Peltdown man~wanted to point out that we did our telephone survey this week so we hope that the information we got is what the banks are doing at this moment. We know that almost all the banks were using the add-on at some time or other. The add-on is being used on car loans etc, we did not check on mortgages.
We did not survey how leases are done but we have a relative who has a company car which is leased and he confirmed that it is on the reducing balance. The leasing company tries to make a profit on the “buy back option”, that is when the person leasing has the option to buy the car at the end of the lease period.
If any BU reader can clarify for us please do.
whatever the arrangements perhaps lending institutions shouldbe required to disclose the interest rate and whether it is add-onor reducing balance. I have noticed that this is now done with car loans to some extent where the dealerships are required to say how much interest is actually payable and at what rate
Thanks to “Another Concern” for highlighting this article which is about CIBC Canada being sued by frontline staff for not paying overtime. Looks like the public in Barbados can learn a thing or two.
CIBC facing class-action suit over unpaid labour
Updated Tue. Jun. 5 2007 4:31 PM ET
CTV.ca News Staff
Two law firms are heading a $600-million class action lawsuit against CIBC, alleging the bank has failed to pay front-line employees for extra work.
The Canadian firms, Roy Elliott Kim O’Connor LLP and Sack Goldblatt Mitchell LLP, announced the lawsuit today, saying the action covers thousands of current and former non-management, non-unionized employees of CIBC.
If this is true, good job exposing a reprehensible practice by BNB and Republic Bank. I wonder how many people would realise the practical implications of this so I wish to contribute the following calculations to help put it in pespective.
I will use a simple example of a $10,000 at 10% interest to be repaid monthly over 1 year. Bear in mind that 10% is a lot less than most people are able to get from BNB.
Under an add-on loan you would make monthy payments as shown below:
$10,000 + ($10,000 x 10% ) = $11,000
$11,000 divided by 12 = $916.67
monthly payments of $916.67
Under the moe honest approach used for lending and using microsoft excel’s function for calculating payments (=PMT(10%/12, 12, 10000), monthly payments are equal to $879.16.
This means the same loan from one of the other banks costs $37.51 per month less per $10,000 annual loan. That is $450 over a year or 1.1% more in the effective interest rate.
This can add up to an awful lot of money when you start to think about longer term loans, like a 5 year car loans due to the compounding effects of interest and time.
Truly shameful. A lot of people smack talk the Canadian banks, but at least they’re honest in the way they present information to their customers.
?~thanks for using the tools to give us a good working example.
A friend of mine in marketing told me years ago that it is surprising the number of people who should know better that get sucked into to the mystery of banking and willingly adopt a meek approach to doing their banking business.
How did you calculate the effective rate? how do you determine the rate that equates the monthly payment using either add on or reducing balance?
Just came across this piece. I have no connection with Barbados, but I have to say that it is an excellent example of good community journalism. An esoteric area of finance made simple, and the unethical (albeit not illegal) practices of a major institution laid bare. Well done!