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MAKING SENSE OF CAR FINANCING
Case study
In Jan 2002, Mr. Tan obtained a 7-year car loan of $90,000 from his bank at an annual interest rate of 2.5%. In Feb 2004, he decided to redeem his loan. The bank calculated the redemption amount using the Rule of 78. Mr. Tan did not understand the bank's calculation and disputed the redemption amount. The bank explained its calculation to Mr Tan and informed him that the method of calculation was stated in the terms and conditions of the Hire-Purchase Agreement.
When you take up a car loan, interest on the loan may be computed in various ways such as on a flat rate basis or a monthly rest basis. The Rule of 78 may apply depending on the terms and conditions of your loan agreement. MoneySENSE provides an illustration of how the Rule of 78 works.
Illustration using the Rule of 78
Using the case study above, Mr Tan took up a car loan of $90,000 over 7 years (84 monthly instalments) and decided to redeem the loan after making 25 monthly instalments. The computation of the redemption amount is as follows:
| Interest rate |
Flat rate of 2.5% per annum
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| Original loan amount |
$90,000 (a)
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| Total interest for 7 years($90,000 x 2.5% p.a x 7) |
$15,750 (b)
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| Principal + Interest |
(a) + (b) = $105,750
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| Instalments Paid |
Monthly instalment = $105,750 /84
= $1,258.93
Total amount paid after 25 monthly instalments = $1,258.93 x 25
= $31,473.25 (c)
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| Rebate of Unearned Interest using Rule of 78* |
$7,808.82 (d)
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| Total amount payable to fully redeem the car loan (assuming no penalty) |
(a) + (b) - (c) - (d) = $66,467.93
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This illustration is not meant to be representative of all situations. You should ask your bank to do a similar calculation for you.
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*Formula used for the Rule of 78
R = [n(n+1)]/[N(N+1)] x TC = [59(59+1)]/[84(84+1)] x $15,750 = $7,808.82
Where:
R represents the interest charges rebate;
n represents the unexpired loan period expressed in months;
N represents the original loan period expressed in months;
TC represents the total amount of interest over the loan period.
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MoneySENSE Tips
Penalty Charges -There may be penalty charges involved for early redemption of car loans. You should check if there are penalty charges in the terms and conditions of your loan agreement.
Effective Interest Rates - You should ask your bank for the effective interest rate (EIR) if it is not stated in your loan agreement. EIR reflects the actual interest cost of your loan. In the above illustration, the EIR of the loan is 4.8% calculated on an advance basis. As banks may not quote interest rates for their loans on the same basis, you should compare the EIR.
The figures in the illustration used were provided by the Association of Banks in Singapore (ABS). For more information on car financing, please refer to the "Car Financing - What You Should Know" information leaflet produced by ABS available at www.moneysense.gov.sg.
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