Interest rate and EIR, although the two critical terms in money lending sound similar, it is crucial to understand the differences between the two.
Usually, when making a borrowing decision from a money lender, you may underestimate the real cost of your loan.
Therefore, in this post, we will discuss the fundamental differences, why they matter, and how to use the new knowledge to compare loan offers responsibly.
What is the Interest Rate?
The interest rate is usually a monthly percentage, representing the cost of borrowing the principal amount. It is the fee charged by the licensed moneylender for lending you money.
Notably, the Ministry of Law in Singapore places stringent caps on interest rates for licensed money lenders. According to the law, the maximum interest rate a moneylender can charge is 4% per month.
The cap applies irrespective of your income or how much you have borrowed. Importantly, this interest accrues only on the reducing principal balance, so with every payment towards the loan, the interest charged in subsequent months falls.
What is the Effective Interest Rate(EIR)?
EIR is a percentage that clearly shows the real cost of the loan. It includes, in addition to the interest rate, mandatory fees for loan processing and administration.
Since EIR incorporates the added costs, it provides you with a more genuine sense of the loan’s actual annual cost. Notably, it’s nearly always higher than the simple annualized interest rate.
Why the EIR is Your Most Important Figure
The EIR is the most crucial factor to consider when comparing two different money lenders. For instance, if two loan offers have the same monthly interest rate of 4%, but one has a high processing fee, its EIR would be higher, making it more expensive overall.
Importantly, the rules on money lending in Singapore require transparency. Therefore, a licensed moneylender is obliged by law to disclose the EIR to borrowers in loan contracts. This level of transparency enables you to be fully informed of the cost commitment up front.
Practical Application of the Knowledge About EIR and Interest Rate
- Always Ask for the EIR: If you ask about a loan, your first question should always be about the EIR? This helps you get a clear picture of the loan’s cost.
- Compare Offers From Different Money Lenders: Use EIR to compare the offers of various licensed moneylenders. The offer with the lower EIR will generally be cheaper, assuming the same loan amount and tenure.
- Read the Contract Carefully: Before signing, make sure that the EIR disclosed in the contract is the one discussed. Importantly, verify all fees, the repayment schedule, and the exact interest rate applied.
- Watch Out for Deceptive Claims: Every money lender must not shy away from informing you of the EIR or the total amount. That is information all licensed moneylenders must provide.
Regulatory Caps in Singapore You Should Be Aware of
Singapore law protects you by enforcing caps on loans, which include:
- Maximum Interest Rate: 4% per month on the reducing balance.
- Maximum Fee: A moneylender may charge a fee not exceeding 10% of the principal loan amount at the time the loan is granted.
- The Total Cost Cap: The total amount repayable is the principal, interest, and fees and it should not exceed the principal amount borrowed, no matter how long the loan lasts.
Conclusion
Knowing the difference between an interest rate and EIR enables you to be a responsible borrower. Mainly, although the interest rate is part of the cost, the EIR represents the real cost for measuring the affordability of loans from licensed moneylenders in Singapore.
Therefore, always compare EIRs across different available loan options, and only choose a licensed moneylender registered with the Ministry of Law.
Importantly, never enter into a deal without a written contract that states all costs. Ensure the financial decision you make is based on complete transparency and disclosure.