What Borrowers Should Know About Effective Interest Rates
Note: The information on Effective Interest Rate below only applies to loans contracted between 1 June 2012 and 30 September 2015. With effect from 1 October 2015, new rules on interest rates shall apply. Please click here (in particular, Q3 and Q4) for more information on the new rules.
The Effective Interest Rate (or “EIR”) of a loan reflects the true cost of taking that loan, by taking into account the frequency of repayments. As illustration, consider two loans, Loan A and Loan B, which have the same principal amount, the same interest payable and the same tenure. Loan A is repayable over frequent instalments of small amounts, whereas Loan B is repayable over less frequent instalments of larger amounts. Even though both loans attract the same amount of interest payments, the fact that Loan A offers less liquidity (i.e. the borrower gets less use of the cash over the loan period) than Loan B means that Loan A is costlier than Loan B. The EIR of Loan A will thus be higher than the EIR of Loan B. To illustrate using actual numbers, consider a $1,000 loan, repayable over a year with interest of $200. The EIR will vary depending on the repayment schedule, as follows:
Repayment Schedule |
EIR |
1 repayment of $1,200 after a year |
20.0% |
2 repayments of $600 every 6 months |
27.8% |
4 repayments of $300 every 3 months |
34.6% |
6 repayments of $200 every 2 months |
37.7% |
12 repayments of$100 every 1 month |
41.3% |
With effect from 1 June 2012, licensed moneylenders are required by law to disclose upfront and in writing, the EIR of their loan packages, so that borrowers would know the true cost of the loan before taking it up. Hence, before you take up a loan offered by a moneylender, you should ask him to provide you with the EIR of the loan in writing. Any moneylender who fails to do so commits an offence.
The calculator below can help you compute and verify the EIR of a loan, thereby facilitating your comparison of the true cost of different loan packages which you may be considering. The calculator requires you to input the following five parameters to derive the EIR:
(a) the loan amount;
(b) the frequency of instalments;
(c) the number of instalments;
(d) whether the instalments are equal or unequal; and
(e) the amount of each instalment.
(Click here to use the EIR calculator)