In the third year of repaying your loan, when you have paid down half of your RM10,000 loan, you still pay the same RM800 interest that you paid in the first year.
However, the outstanding loan amount is only RM5,000 as you have already repaid half of it in the first two years. That means your interest rate has now jumped from 8% to 16% (RM800/RM5,000).
In the first year, your interest rate would be 11% (RM 800/RM 7,500) and in the last year, it would be a whopping 32% (RM 800/RM 2,500).
If you were to calculate the average interest rate on the loan, it is not 8% as advertised, but almost double that, at over 14%!
This is calculated by taking the actual interest you are paying versus the amount of the loan that is still outstanding (that you still have in your possession and benefit from), instead of the total amount that was taken out initially.
Depending on your loan duration, the average interest rate is 1.6 times – 1.8 times higher than the flat rate. That is why many countries stipulate that banks show the “true” interest rate, called “effective interest rate: (EIR).
Other countries, such as Singapore and the US use APR, or Annual Percentage Rate, which boils down to the same idea, but – depending on local laws – can include sign up, admin and handling and other (upfront) costs.
You don’t need to calculate the effective interest rate yourself. Bank Negara mandated that all banks in Malaysia disclose this information.
So where can you find it? Find the Disclosure Sheet for the personal loan online and look for the “effective lending rate” or “effective interest rate”.
Other costs you should take into account are the stamp duty and handling or processing fees. Also take into account early settlement fees and late payment fees.
Don’t allow yourself to remain misinformed about the true costs of personal loans. Understand the true interest rate of loans, consider whether a loan is a good idea for your financial needs, compare the lowest rates and apply!
Mark Reijman is co-founder and managing director of https://www.comparehero.my/, dedicated to increasing financial literacy and to help you save time and money by comparing all credit cards, loans and broadband plans in Malaysia.
