For sure you are familiar with the term interest rate, which is the amount that financial institutions charge in exchange for the assets they lent. It is often expressed as a percentage of the principal loan amount.
But, have you heard of the term effective interest rate (EIR)?
In this article learn all things about EIR. And, discover why everyone who has a loan or is planning to apply for one has to understand this concept.
Advertised Interest Rate vs. Effective Interest Rate
The advertised interest rate (also known as nominal interest rate) is the interest the bank charges you on the sum you borrow.
The effective interest rate, on the other hand, is an interest rate that reflects the true cost of borrowing to the consumer. This often includes service fees or admin charges charged upfront for processing and approving your loan application, so it is usually higher than the advertised interest rate.
How to Calculate Your EIR?
It is possible that you can calculate the EIR of your own loan. Here is the formula followed by most banks:
[1 + (nominal interest rate / number of compounding periods) ^ (number of compounding periods)] – 1
But, to be honest, this formula can be difficult to follow. For one, banks have their own definition of what is a nominal interest rate or a compounding period. It is recommended then that you ask the bank how they compute the EIR of their offerings and then compare which of them has the most affordable deal.
Remember that by law, financial institutions in Singapore must publicly release the EIR of their loans which means that as a borrower, you have the right to read the fine prints of the loan details including the EIR.
What’s a Good Effective Interest Rate on a Personal Loan?
Credit companies offer best personal loan with different effective interest rates ranging from 7% to 25%. If you are lucky, you can find a lending company that could give you a 6% EIR if you have a high credit rating.
In most cases, borrowers would choose an offer with the lowest EIR because they would mean that they are charged less in a span of a long period of time.
But for some borrowers, the total interest rate is not the only factor to consider when taking a loan. For them, you must also think of loan tenure and your monthly income. A longer tenure might mean higher EIR, but it would also mean that you have more time to repay the amount you own.
In the case of your monthly income, you have to make sure that your monthly income is enough to repay the monthly payment incurred by your loan.
Fees That Effective Interest Rates Don’t Factor In
In an ideal world, EIR should reflect the true cost of loans, but in the real world, there are still expenses not covered by the EIR. These fees are called circumstantial fees which means that not all borrowers have to pay them. Still, it is important to know what these are in case you are charged with these fees.
- Early settlement charge – a penalty for paying the loan early. Take note that not all banks charge this.
- Late charge – a penalty for paying tpast the due date. These usually cost $80. It is more common for banks to charge this than the early settlement charge.
- Nonsufficient funds or returned cheque charges – a penalty incurred by a borrower who made a payment from an account without enough funds. If the payment transactions fail, the borrower is charged with the same amount as the fee.
Effective interest rates from banks
Here’s a comparison table of the top banks in Singapore offering personal loans. This calculation is based on a $10,000 loan amount with a loan tenure of 3 years.
Note that these rates (As of June 2021) may change without prior notice.
|Effective Interest Rate
|Standard Chartered CashOne
|HSBC Personal Loan
|Citibank Quick Cash (New Customers)
|UOB Personal Loan
|OCBC Extra Cash Loan
Other Things You Should Know
There is much to know about the effective interest rate and how it may affect your financial life. Here are some of the different questions you may ask about this topic.
Why is the EIR higher than the advertised rate?
Yearly or monthly interest rates are traditionally expressed as a percentage, but banks may charge other fees including administrative fee that get added to these percentages.
If a bank lent you $5000 and is charging you a 5% interest rate, you get to pay $250 for the entire year. But this is not the only interest payment you have to make. There are more interest such as admin fees or processing fees.
Let’s say that the bank charged you $50 for the processing fee. This adds to your EIR. Aside from this, EIR also takes into consideration the repayment schedule, which could increase the amount you are charged with.
How Does the Repayment Schedule Affect EIR?
In simple terms, the more frequent repayments you have, the higher your EIR will be.
For example, if your loan with 1 repayment has an EIR of 5%, the same loan with 12 repayments has an EIR of 9.49%. Remember that the sooner you repay the loan amount, the less cash is left to you. This means then that you have to choose a loan with long loan terms and fewer repayments.
Do personal loans help my credit?
It depends. If you manage it well, like pay the due amount on time and pay it fully, your score or rating will increase. But, if you miss payments or decide to default or settle your loan with a debt relief company, your score will decrease. If you are not sure that you can manage the effective interest rate and other different charges you will be paying in your loan, it is best not to take it.
How can I get a low-interest personal loan?
In Singapore, the easiest way to do this is to compare deals offered by financial institutions. Check who has the lowest EIR. You can also check the interest rates, the amount you can borrow, and the length of time you have to pay back. Assess if the interest rate used by the financial institutions is lower than their competitors.
How can I get the lowest EIR?
Ask your bank or any financial institution about the EIR of their loans. Do not rely on the advertised rates of their products. If you find their EIR, interest rates, or other costs too high, you can negotiate with them directly. Remember that these are the people behind these financial services.
How is EIR calculated?
The effective period interest rate is equal to the nominal annual interest rates divided by the number of periods per year
Here’s the formula: [1 + (nominal interest rates / number of compounding periods) ^ (number of compounding)] – 1
What is the difference between interest rate and effective interest rate?
Interest rate is the annual percentage of interest that you earn on your deposit. Effective interest rate, also known as nominal or simple-interest rates includes all commissions and fees associated with borrowing money to invest in a particular time period.
What’s a good effective interest rate on a personal loan?
Effective interest rates vary from 7% all the way up 25%. The lowest effective rate will be for people with good or excellent credit scores.
Should I choose the lowest EIR?
Do you want the lowest monthly repayment or are you looking for a more cost-effective option? If your goal is to make it as easy and affordable as possible, then going with an EIR that has a higher APR might be better. This will allow lower payments over time because of longer loan tenure.
Borrowing money can be a tough thing to do. There is so much information to read and understand. Aside from the effective interest rate, you must also be familiar with interest rates, nominal interests, lending costs, and many others.
If you truly want to find the best deals for loans, you have to be vigilant in finding financial institutions with reasonable charges. Aside from the advertised rates, ask the representative to calculate other additional costs. Also, compare if the product you are applying for will cost you least. You have to make sure that applying for personal or other type of loan is the best financial decision for you.
If you wish to know more about personal term loans and other details about lending products in Singapore, visit Instant Loan now. They are a finance directory website that lets you receive free loan quotes from Singapore’s top financial institutions.