In a nutshell, interests are the price paid by the Borrower for the amount borrowed from the lender (Banks). The difference between an interest and an interest rate (or ‘profit rate’ if it is an Islamic Loan) is straightforward; the former relates to the amount the Borrower pays (the actual money paid) while the latter refers to the percentage used to calculate the amount of interest that will be paid over the loan period.
Interests are commonly charged on personal loans, car loans, house loans, overdraft facilities, credit cards, education loans, business loans, investment loans and many more.
As much as we hate paying interest, it is imperative to understand the reason behind it. Firstly, the Banks do not lend money out of the goodwill of their heart (however badly we wish for it >-<). The interest income is the main way most commercial banks earn money. Moreover, it is safe to say that lending money comes with its risks because there is a chance the Borrower absconds and the money is not paid back hence the Banks need to be compensated for bearing the risk. Banks need to also protect themselves from the risks of inflation as well.
On the other hand, everything comes with a price. The Borrower is given the chance to get his / her hands on a big amount of money quickly. They could be a car owner or a homeowner NOW instead of sometime in the uncertain future. The price they pay for this convenience is the interest.
Now that we have understood some practical reasons as to why interests are charged, let us take a look at some of the common types of interests that exist.
Flat Rate Interest | The interest is calculated based on the original principal amount for the entire duration of the loan. |
Compound Interest | The interest is calculated on the original principal together with the accumulated interest from the previous periods. |
Credit Card Interest | The interest charged on outstanding credit card balances. |
Overdraft Interest | The interest is charged on the overdrawn amount when the current account exceeds its balance. |
Fixed Interest Rate | This interest rate remains the same for the entire loan duration. |
Floating Interest Rate | This interest rate fluctuates over time. |
Each type of loan has different interest rates due to the credit risk involved, tax, loan period and Borrower’s creditworthiness. It is also possible for each bank to have different interest rates for the same type of loan. This is possible because of the Base Lending Rate (“BLR”) / Base Rate (“BR”). This can be described as a “reference rate” / “benchmark” that Banks use to set their own rates upon considering certain factors like operating expenses and market competition. Each bank has its own BLR based on the policies laid down by the Bank Negara Malaysia.
A lower interest rate is what all of us look for because… well, who wants to voluntarily pay a lot of money? This is why it is vital to “shop” around and compare different rates set by different banks to find one that best suits each individual given their financial budget and expenses. Below are some ways a lower interest can be secured:
Have a Good Credit Score A credit score shows the Borrower’s creditworthiness. In other words, it is to see if the Borrower has been a good paymaster. The Bank checks on the repayment history, number of accounts and amount of debts paid. If the Borrower has a good credit score, then it is highly likely that the Bank would approve the loan and charge a lower interest rate.
Guarantor If a financially strong guarantor co-signs the loan agreement, then the Banks can reduce the interest rate.
Collateral If the Borrower can pledge any valuable asset like jewellery, cars, or stock certificates, the Bank will take the asset as insurance. The loan would then become a secured loan. The Bank would feel much safer to lend money since the Bank can rely on the value of the collateral in case of default in payments, making it possible to secure a lower interest rate.
Larger Down Payments If the Borrower manages to put down a large down payment, then the principal amount that he would need to lend (the loan amount) would be lesser hence resulting in a lower interest rate.
In conclusion, understanding how interest rates work and taking proactive steps to secure lower rates can save you a significant. By maintaining a good credit score, offering collateral, securing a strong guarantor, or making larger down payments, you can make borrowing more affordable. Remember, a little effort in planning and research can go a long way in managing your finances effectively.
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We trust that you have gained some information from this article. If you have any specific questions related to this article, please contact us at askdwc@dwc.com.my.
The article posted is for general information purposes only and should not be construed as legal advice. Facts and circumstances differ from case to case. Please consult your lawyer for specific legal advice and action to be taken.
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