I don't buy personal loans

Then why am I writing about this?

In recent times after the Overnight Policy Rate (OPR) was cut and banks gave out loan moratorium (6 months deferment of repayment of loan instalments), I’ve received countless of calls and messages from banks promoting their personal loans and balance transfer products. One of them (Rhymes with City) keeps on calling me every week although I have rejected them countless times. Talk about persistence (or annoying).

I picked up the first few calls just to listen to what they have to say. All of them have the same story. They will mention they have this loan / balance transfer program and it is now at a very low interest rate, so would I like to take it up. Some would even probe whether I would need “financial assistance” for my daily life. Sounds nice, but is it really?

As the constant sales call persists, I can’t help but have questions in my head:

Are those people who really need these “financial assistance” getting such calls? (My assumption is… No)
Is there any scenario whereby I will consider taking up a personal loan?

And we will need to look into this product “personal loan” to answer the latter question.

The reason for taking a personal loan

Personally, I don’t like the thought of a loan (pun intended), but I also believe in the concept of good loans and bad loans. Which one does personal loan fall under? It depends on the use.

In the case of a personal loan, there are some common reasons to take up personal loans, such as medical, home-related, wedding, debt consolidation, education.

I can find justification to use it for debt consolidation – which is the act of taking up personal loan to pay down other loans that are carrying higher interest rates (mainly). Even this, I would take it as a last resort. Reasons in the sections below.

For the other reasons, I cannot find myself to take up a personal loan for it. Why?

It all falls down to the money principles we live by

One of the most important money concept is to understand needs vs wants.

Ultimately, if we have to take up a personal loan for our “wants” then it means we are spending beyond our financial capabilities.

On the other hand, if we take up personal loan for a “need” then it seems that there is a survival sustainability issue that we should be tackling first.

If we ignore that part…

Let’s assume I am looking to take up a personal loan

Where should I start? I can look at the Malaysian comparison websites for the different available personal loans in the market – RinggitPlus, iMoney, CompareHero, LoanStreet. They each provide a long list that we can compare.

5 main elements of a personal loan to consider

(1) Loan amount / quantum

The amount of loan to take up should reflect the reason for taking up the loan in the first place. However, this amount is also dependent on what the lenders are willing to give out to an individual based on their “ability to borrow” (aka Deb Service Ratio as explained in the next section).

What is generally available in the market:

Min loan amount can be as low as RM2,000
Max loan amount is on average between RM100,000 to RM200,000

(2) Tenure / period of loan

Tenure refers to the length of the repayment period. Generally, the longer the tenure, the higher the interest rate (Refer to No.3) and the lower the monthly installment amount (Refer to No. 4).

Depending on the lender / banks:

Min tenure is either 1 or 2 years
Max tenure is generally 10 years

(3) Interest rate vs Effective Interest Rate (EIR)

One of the biggest consideration between different lenders is the interest rate offered. In the current market the interest rate is pretty competitive and may be lower compared to historically because of the OPR cuts.

What I’d like to touch on here is the 2 different interest rates that we should pay attention to – Annual Interest Rates vs Effective Interest Rate (EIR).

Annual Interest Rate

This is the often published & advertised rate that banks quote and is typically a fixed rate. This is similar to car loans, whereby the interest rate and (essentially) our monthly installment amount is the same throughout the entire tenure, be it rain or shine.

Effective Interest Rate (EIR)

Unlike some other countries whereby EIR is compulsory to be published along with the annual interest rates, Malaysians have to calculate the EIR ourselves in most cases.

EIR is the true cost of the personal loan.

Imagine this. We agreed on a loan arrangement where I will lend you RM10,000 at a 5% annual interest rate for 10 years.

Yearly interest repayment is RM500 (= RM10,000 X 5%) and
Yearly principal repayment is RM1,000 (= RM10,000 / 10 years).
This means that the total yearly repayment is RM1,500

After year 1, your principal amount remaining is RM9,000 (= RM10,000 loan amount – RM1,000 year 1 principal repayment). However your interest rate for the year is still fixed at RM500. This translates to year 2 interest rate of 5.6%.

What this reflects is that although you borrowed RM10,000 upfront:

You will not be able to use the RM10,000 throughout the entire period as your repayment includes your principal repayment, and
The interest rate will be calculated based on the full amount regardless of how much of the principal amount you have repaid over the tenure of the loan.

On top of that, some of the personal loans have other upfront charges (Refer to No. 5) and this will cause the loan amount of RM10,000 to reach your hand at less than the full amount. But… your interest rate is still calculated on RM10,000.

We can use the EIR calculator available on LoanStreet’s website to convert the fixed rates to EIR.

Interesting thing I noted is that the EIR is usually about double of the fixed rate published. This makes the EIR more than 10% generally.

(4) Installment amount

The installment amount is essentially influenced by the loan amount, the interest rate and the tenure of the loan.

I will not go into the details of how to calculate in this as it seems pretty straightforward.

However, the key question here is “Can I afford this monthly installment period?”. This is when knowing our living expenses vs our income becomes important to know how much more loan repayments we can afford.

(5) Other charges

These are usually Processing Fees and Stamp Duty.

From a quick glance, I see that there are usually no processing fees charged and stamp duty is either waived or 0.5%.

It is crucial to check on this as it affects how much we actually receive in loan. A loan amount of RM10,000 may only end up RM9,900 when it reaches our hands if there are these upfront charges of a mere 1%.

BTMar shows the 5 elements for personal loans

How much personal loan can I borrow?

Generally when we look at how much more of a loan we can take on, we will look to something called the Debt Service Ratio (DSR).

This is essentially looking at your income vs your debt obligations to see if there is any room to take in more.

The formula goes like this: DSR = monthly commitments / monthly income, whereby the monthly commitments refer to the loan obligations that we have taken up to today (car loan, house loan, personal loan, etc).

The ratio that is used depends on the lender and can range from 50% – 70%.