The proposals would see credit unions taking control of crisis lending
Emergency state loans given to the poorest people in the UK could cease to be interest free, under changes being considered by ministers.
The social fund currently extends £500m a year in interest-free loans to some 1.2 million benefit claimants.
But the government says in future some loans could be run by credit unions, who it says typically charge annual rates ranging from 12.68% to 26.8%.
The Tories accused ministers of acting like "loan sharks".
The BBC's political correspondent Jo Coburn said the reforms were designed to ensure that interest-free loans were not offered to people who did not really need them.
The social fund was set up to help needy people, many of them elderly or disabled, meet the costs of items such as cookers, cots and funerals.
Details of the proposed changes were released in a Department for Work and Pensions consultation document.
It states that the government is considering offering contracts to credit unions to provide "affordable loans", as well as other services such as savings accounts and financial advice, to people at a local level.
"To fund the cost of these extra services, we are proposing that the credit offered under these arrangements could attract an interest charge of 1-2% per month," it says.
The paper states that credit unions of the sort they are considering "typically charge interest at rates varying from 12.68% to 26.8% APR".
The DWP said that in 2007/8 the average "budgeting loan" given by the social fund was £433.30, and the average repayment was £10.54 a week.
In future, if interest were charged at 2% a month, it would take 46 weeks to repay that amount instead of 42, with total interest of £47.80.
HAVE YOUR SAY
The people who need it the most will suffer while those who milk the system will not notice a thing
Steve Godrich, Reading
A Department for Work and Pensions spokeswoman said: "The social fund provides affordable credit for people who need it.
"We are now exploring how we can make it more widely available to people in work as well as on benefits.
"We want to make sure people in need do not turn to illegal loan sharks who can charge interest of 1,000%."
No decisions had been made and the government would do nothing to create difficulties for low-income families, she added.
Labour MP and chairman of the Treasury Select Committee John McFall told the BBC that the social fund "does not work".
"The government needs to... ensure that people get the genuine loans and genuine needs met," he said.
"To put a 26.9% interest rate on that seems to me that it would make a bad situation even worse, so I think that's a bit of a joke."
Shadow work and pensions secretary Chris Grayling said: "These proposals are simply outrageous.
"Thousands of people are losing their jobs every week, and it is nothing short of extraordinary that the government's answer is to propose abandoning interest-free emergency loans, and start charging 27% a year instead.
"Gordon Brown and [Work and Pensions Secretary] James Purnell are behaving like loan sharks."
The Liberal Democrats said the proposal was "totally unacceptable" and "seemed to be destroying the purpose" of the social fund.
Treasury spokesman Vince Cable told the BBC: "It's completely self defeating. It's just driving people who are already in difficulty into even further difficulty.
"It's harsh, it's insensitive and it doesn't reflect the needs of the day."