A PERSONAL loan is a great tool to help you out when you experience cash flow problems. Provided the loan repayment does not cripple your ability to pay for your other expenses of course.

However, little do you know, the interest on the loan is actually higher than advertised, because the “true” interest you pay on your loan is only mentioned in the details. Once again, the devil is in the detail.

The interest rate that is advertised is called a “flat” rate or “simple” interest rate. If you would pay an 8% flat rate on a RM 10,000, four-year loan, it means that in each of the four years you will pay RM10,000 x 8% = RM800 in interest.

Of course, you will also have to repay the original loan amount (principal amount). At the end of each of the four years, you will have to repay RM2,500.

That means the calculation of your interest charges and total instalment is very straightforward and easy to calculate. It is as easy as adding RM 2,500 (principal) + RM800 (interest) to a total yearly expense of RM3,300 per year (or RM 275 per month) for your RM 10,000 personal loan.

This makes the interest rate of a personal loan seem lower than it actually is, so don’t be fooled!

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!

Source Star business

Sunday, 15 January 2017 | MYT 4:23 PM

Paying high interest rates for personal loans

by mark reijman