KUALA LUMPUR — Buying a vehicle in Malaysia is set to become fairer for consumers, thanks to long-awaited amendments to the Hire-Purchase Act (HPA) that will overhaul how car loan interest is calculated.
The changes are designed to give borrowers more transparent terms and greater savings, especially on early settlements.
Here’s what you need to know.
The new law abolishes the “Rule of 78” and “flat rate” interest calculations for all future hire-purchase loans.
These will be replaced by the reducing balance method, a more fair and simple formula that is already the standard in countries like Australia and the UK.
The way your interest is calculated has a huge impact on how much you pay and when.
Here’s how the methods differ, using a simple example of a RM12,000 loan over 12 months at a 6 per cent annual interest rate.
Old method 1: Flat rate
This is the simplest but most misleading way to calculate the total interest. The interest is calculated on the full original amount for the entire loan period, regardless of how much you’ve paid back.
Calculation: RM12,000 x 6 per cent = RM720 total interest. Your total repayment is RM12,720, or RM1,060 per month.
In the example above, you continue paying interest on the full RM12,000 every month, even when you only have RM1,000 left to pay.
It is simple, but it is unfair to the borrower.
Old method 2: The Rule of 78
The name “Rule of 78” comes from the sum of the digits 1 through 12 (representing months in a year), which adds up to 78. This sum is used as the denominator when calculating how much interest is allocated to each month, with the month being the numerator.
This rule takes the RM720 in total interest calculated by the flat rate and determines when you pay it. It “front-loads” the interest, meaning you pay a much larger portion of it in your early instalments.
Let’s see how this affects your monthly payment of RM1,060.
Let’s see how this affects your monthly payment of RM1,060.
Month 1: Out of your RM1,060 payment, a huge RM110.77 goes to interest. This means only RM949.23 is used to pay down the actual RM12,000 you borrowed.
Month 12: Out of the same RM1,060 payment, only a tiny RM9.23 is for interest. A much larger portion, RM1,050.77, now goes towards clearing the principal.
The problem: Because most of the interest is paid off early, if you decide to settle your loan after six months, you would have paid off very little of the actual RM12,000 principal. This means your early settlement savings will be minimal.
It heavily penalises borrowers who want to pay off their debt early.
