keep your vehicle financing within your personal means, and always do your homework before signing above the dotted line.
Would you like to get a new car? For what length of time will you take up a loan for? Some people opt for a 9-year loan, but plan to pay it off early to save money on interest. But does it really work like that?The issue of increasingly long loan tenures for auto loans is also gaining traction in the US. But then again, how long is too long really? Should you just get a car for a five-year loan? How does the bank calculate the interest? Some might argue that in order to save money on interest, it's preferable to take out a longer loan of nine years with smaller monthly instalments and then settle early.
That is partly accurate, but keep in mind that banks have done their homework, so it is somewhat impossible to outwit them. Naturally, nine-year auto loans are becoming the standard norm in our market due to its low monthly commitment, but you also need to take into account of the hire purchase repayments, which are computed using the principal amount.
Rule of 78 is a method of calculating interest that ensures the maximum interest is paid at the beginning of the loan.
Let’s put things in perspective. When you take a 9-year loan for RM 80,000 at a 2.8% interest rate, you’re paying RM20,160 in interest alone – which is a huge sum of money. Even though the borrower is paying off their loan approximately 50% faster, there won't be much in the way of interest charge rebates if they settle early.This is as a result of something known as the ‘Rule of 78’, which is one of the most widely used and little-known secrets in the banking sector. You might have already experienced this sneaky tactic without realising it and lost out as a result.
Also referred to as the Sum of Digits Method, the Rule of 78 is a method of calculating interest that ensures the maximum interest is paid at the beginning of the loan. With an aim to minimise borrowers' savings from early loan settlement, this practice is commonly used for both personal and car loans. Instead of spreading the cost of financing evenly across instalments, banks quietly allocate the majority of the interest to the beginning of the loan.The Rule of 78 allows banks to charge up to 80% of the total interest payable during the first half of the loan's term, ensuring them a large profit if a borrower decides to settle early. Surprisingly, having the public focus solely on "rebates" and "discounts" for early repayment of personal loans and car loans is one of the most successful marketing stunts pulled by the banking industry. As a result, most people didn’t realise how the Rule of 78 works against them.
Chery Malaysia showcased the upcoming Chery Tiggo 7 Pro model recently. This C-segment SUV offering is set to launch in May this year.
Currently, Rule of 78 is actually banned in several countries like the United Kingdom, Australia, New Zealand, and the United States due to its blatant rip-off nature. There, banks are only permitted to use Rule 78 for loans lasting no more than 5 years.
For our local market, the Malaysian Consumer Credit Oversight Board Task Force (CCOB) has proposed abolishing Rule of 78, citing similar rip-off nature as the main reason for this move. As of now, however, Bank Negara (BNM) has yet to make any decisions on the matter.
Regardless of what BNM decides, it is in fact a bad idea to purchase a car with a nine-car loan. Besides the reason we’ve discussed above, other drawbacks of taking out a nine-year loan is that the value of your car will decrease more quickly than your ability to repay the loan, meaning you won't be able to sell it for cash without having to put more money down to cover the remaining balance.
Of course, there is an opposing viewpoint that argues longer-term loans are preferable since they improve cash flow. A person who takes on more debt to maintain cash flow in order to continue paying his bills is not the same as someone who maintains cash flow in order for his business - or personal wealth - to grow.
By day’s end, it all boils down to doing your best due diligence before financing for your next new vehicle, as they can have a huge impact on your personal finance in general. So much so that the Malaysian Department of Insolvency said unpaid auto loans account for the majority of bankruptcy cases filed by individuals in the country between the ages of 35 and 44.
Remember, the key here is to keep your vehicle financing within your personal means, and always do your homework before signing above the dotted line.
