Most people think that it is a good idea to pay off car loans before the loan tenure ends to avoid the hassles of monthly payments and high interest rates. But it’s not that simple.
Cars in Singapore are extremely expensive: the price of a base model sedan in the city-state is enough to buy a top-of-the-line SUV in other countries. For example, a $14,000 sedan in Southeast Asian neighbor Philippines can fluctuate to over US$60,000 in Singapore, as the latter’s government wants less cars on the roads.
This is enough reason for Singaporeans to pay off their car loans earlier than the loan period, in order to cut off obligations once they find the money to do so. Or maybe they want to sell the car, but cannot do so as the car loan is not yet fully-paid, therefore opting for early settlement.
But while it is possible, it is not simple and it may come at a price.
What Is the Rule of 78?
Early redemption or early payoff calculations for car loans in Singapore are based on a system called Rule of 78. This is basically a method used to calculate interest charges on a loan that would be repaid earlier than usual.
Rule 78 is named as such because a 12-month loan would have interest payments depending on the proportion of the month that payment was completed. As there are 12 months in a year, adding the ordinal designator of the month would yield a result of 78 — hence the name.
Formula: 12 + 11 + 10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 = 78
This means the amount of loan interest paid for the eleventh month would be twice as high as the one that would be paid by the twelfth month, while the loan interest paid for payments in the first month would be twelve times higher than the payments for the twelfth month.
Example: If you have settled the loan on the ninth month, then your interest rate fraction would be 10/78 — as paying on the ninth month means your loan interest is four times as high as the interest for the twelfth month. The numerator is based on 4+3+2+1 = 10.
Under this example, paying earlier — like into the third month of the loan which will yield a bigger interest rate fraction of 55/78 — or a higher interest payment.
This means that it is possible to settle a car loan earlier — like paying it off four years into a seven-year car loan — but you may not save a lot. Therefore, complying with the existing loan tenure may be a better option for some.
How Do Financial Institutions Calculate Interest for an Early Payment Scheme?
The formula for the Rule of 78 is quite tricky. As a result, some banking agencies in Singapore have derived a similar formula which is easier to understand, as it shifts the attention towards the remaining interest and not the remaining payable amount.
While there are a wide selection of calculators available, it would be best to know the details of additional payments behind an early payment scheme.
1. Calculate remaining interest
- First formula: n(n+1) it can be translated to this if a borrower has already paid off four of seven years or 36 of 84 months in the loan > 36 (36+1) = 1,332
- Second formula: N(N+1), wherein N is identified as the original loan period in months > 84 (84+1), which is 7,140.
- Third formula: [n(n+1)] is then divided by [N(N+1)], which in this example, would yield an answer of 0.1865 > 1,332/7,140. = 0.1865 remaining interest
This answer is then multiplied to the total amount of interest payable within the whole loan period.
2. Calculate the total amount of interest payable
Using the Toyota Vios as an example — where you may get a loan of S$59,500 after your initial down payment, which carries an interest rate of 2.78 percent per year — users should first calculate the total payable interest.
Loaned money x interest rate in decimal form (transferring decimal point two spaces to the left) x number of years = worth of total amount of interest
S$59,500 x 0.0278 x 7 = $11,578.70 total amount of interest
3. Finally, calculate the unpaid interest
Now that the factors are complete, you can multiply 0.1865 (remaining interest) by $11,578.70 (total amount of interest), which is $2,159.42 worth of unpaid interest.
While interest per month is at $137.84. Monthly payment is at $846.17.
Remaining interest x total amount of interest = unpaid interest
0.1865 x $11,578.70 = $2,159.42 unpaid interest
Is Paying Off a Car Loan Early Worth It?
If you would like to know whether you were able to save money by paying a car loan earlier than its set tenure, then you would find out that there is a slight difference: you would still actually pay more if you stuck with the loan tenure, in this case, a seven-year loan.
But car loan applicants would have to remember that banks still charge early settlement penalties on top of the total redemption amount. Usually this is at one percent to 1.5 percent of the total financed amount.
For the Toyota Vios, you would pay $71,078 if you follow the seven-year loan tenure, but complete repayments four years into the loan would require a total loan redemption amount of $29,627.27.
This means you would have spent a total of $70,343.67 including the early settlement penalty if you pay this seven-year loan three years earlier — a difference of $1,726.83.
Complete seven-year loan | Early redemption (5 years) | |
Total initial loan amount | $59,500 | |
Total/ remaining interest | $11,578.70 | |
Monthly payment | $846.17 | |
Remaining/ unpaid interest | 0 | $1,727.53 (Rule of 78) |
Amount already paid | $71,078.70 | $40,616.40 |
Loan redemption amount | 0 | $28,734.77 |
This is quite a small change considering that you practically shaved off three years from the loan tenure. But the worthiness of early settlement depends from one customer to another: there are those who value financial security and thus would consider paying off loans earlier, while some may look to invest available money for it to grow over time.
Benefits of Paying Off Your Car Loan Early
While paying off car loans ahead of time is not everybody’s cup of tea, especially with growing day-to-day expenses, it actually has a lot of benefits. Even with the Rule of 78 in place, you stand to save some money, which can be allocated to other expenditures or investments.
Enable you to save.
In the example used, paying a car loan four years into a seven-year contract would enable you to save $1,726.83 — a small part considering the years removed from the loan, but at the same time a generous amount that can be used for other purposes.
So for paying your car loan in advance, you actually get to set aside an amount that almost compensates your expenses for a month.
Avoid paying more than your car’s value.
Although as mentioned earlier, car prices in Singapore are already bloated that the price you are paying for may actually be twice or even thrice its value. Still, avoiding unnecessary payments is still a good thing.
How to Pay Off Your Car Loan Earlier?
If you really want to end your car loan, or maybe you want to get a new car and would have to sell your old car that still has remaining payments, the best way is to accumulate funds first before deciding on early redemption.
There are ways to do this:
- Look for other jobs. Set up a business, or basically increase your income. You can also look for part-time jobs which would help you complete the loan.
- Use your bonuses. One thing you can do is to set aside all extra income and bonuses that are excesses to what you need monthly. From this, you can actually save money to pay the early redemption costs.
- Use another loan to cover another loan. Like a debt consolidation program. Loan finders in Singapore like Instant Loan offer loans that would give you the money needed for the early redemption of your car loan.
What this would do is to give you more options on how to settle your car loan. You can also save some money because interest options may be lower than what your car loan offers.
You can visit Instant Loan, a loan comparison site that sends you free quotes from top financial institution providers so you can weigh in your options and make smarter financial decisions.