Maximize Your Money: Hire Purchase Loan.

I always love to talk about hire purchase loan more often because it is the most misunderstood loan in the market. I have seen friends and families who have been making the same mistakes over and over again. I’ll open your eye and show you the right way of managing your hire purchase loan. Before you proceed, go through ‘Back 2 Basic: Hire Purchase Loan’. Now, start your engine and ready to roll on.

(Note: All this maximization will work in Islamic loan as well)

Let’s look at some common tips (truth) about hire purchase loan.

1. Always take the shortest tenure

The reason is very simple, the longer your tenure is, the higher your effective interest rate will be. Remember that, hire purchase loan would calculate your interest using the borrowed amount multiply the number of years, which will increase your effective interest rate. Not just that you’ll be paying a very high interest in the first year itself.

2. Take the least amount of loan possible.

I have come across many car dealer advertising ‘0% down payment’ or ‘100% loan’. Some who might have some additional cash to pay for down payment would just take the 0% down payment offer. He might even be proud that he doesn’t have to put any money to buy the car. But, the effect is huge. With the amount of effective interest you’ll be paying, you’ll be losing in interest. If your loan interest is 5%, a $5,000 down payment would save you $1,250 for 5 years tenure and $1,750 for 7 years tenure. So, take the least loan.

3. Do not make additional payment

“What don’t make any additional payment? Are you crazy?” some might start to think I’m crazy. The reason is very simple; your additional payment won’t be reducing your hire purchase loan interest. You will only reducing your payment period, but not the interest at all. The next tip will make understand way making additional payment is a waste and teach a better way of making additional payments.

4. Pay at the end of grace period/due date.

You''ll be usually given 7 days period from billing date or beginning of the month to pay your installment. Many might even pay them on 1st day itself. Some might pay them even before the beginning of the month. By paying earlier, you are not gaining anything, as you are not reducing interest. In fact you are only helping the bank. So, try to pay at the end of grace period around 6th or 7th day. (Just don't exceed your due date)

So far, whatever tips you read might be quite common found everywhere. The next final tip is what will make you different than others. It is how you maximize your hire purchase loan.

"Whatever additional payment, save them instead."

That’s right, if you are going to make additional payment, save that money in savings, fixed deposit or unit trust, whichever you are feeling comfortable with. Save them into something which could give a return with low risk. Then, when your saving amount is equivalent to your balance minus rebate, pay them off one shot. Let’s have a look at illustration below.
Mr. Karipap never made any additional payment, while Mr. Dodol made additional payment all the time.


Now, let’s look at Mr. Cekodok. He maximized his money by saving the money for additional payment in a fixed deposit of 3% p.a interest. The below calculation done based on monthly savings.


Just imagine, how much you could save if you had invested in something which could give 5% return.

All in all, whenever you are going to buy car or getting any other hire purchase or Islamic loan, follow the tips above to maximize your money and towards a better money management.

Good luck and all the best.

Back 2 Basic: Hire Purchase Loan

Hire purchase loan is a contract which the buyer become the hirer and the bank or financier financing the goods (example: car) become the owner. You’ll be paying installment to the bank for duration as agreed in the contract, while you’ll have the possession of the car, not the ownership. As soon you have finish paying all installment, the ownership will be transferred to you.

The concept is, you be renting the car from the financier, at the end of the contract you’ll buying back the car at a predetermined price. In reality when you pay your installment it is considered as covering for the rental as well the predetermine price paid by installment.

(Note: Islamic loan use the same method of calculation as hire purchase loan)

How they calculate the interest?

Loan amount × Interest × Number of years = Total Interest

How to calculate the monthly installment?

(Loan amount + Interest) ÷ Number of months = Your monthly installment

Let’s look at an example.

Mr. Ali Babu Cheng (aka Mr. ABC) bought a brand new car for $55,000. He used $5,000 from his savings for the car down payment. He took a hire purchase loan from Iwantyourmoney Bank (aka IWYM Bank) for the balance $50,000. IWYM Bank charge an interest of 5% and the loan tenure is 5 years.

Total Interest = $ 50,000 × 5% × 5 years
= $ 12,500 (Total interest charged)

Monthly Installment = ($ 50,000 + $ 12,500) ÷ 60 months
= $ 1041.67 (The amount Mr. ABC have to fork out every month)


Every month when you make payment, part of the installment will be used to pay interest and another part to settle the principal amount. So, next question my fellow students, what is the amount of interest paid for the 1^st year by Mr. ABC?

Most people might calculate this way,

Total interest ÷ 5 years = Yearly interest charged

So, the interest paid by Mr. ABC for the 1^st year is, $12,500 ÷ 5 = $ 2,500 and interest portion paid per month, $2,500 ÷ 12 = $208.33

That’s what a lot of people think, but the truth is its totally wrong.
Get ready, it’s rather complicated. Here is how it’s calculated,

Step 1:

Add all number from1 until number of 'Total months'. Let's call it sum of months.

Example:
Total months= 60
Add all the numbers from 1 to 60.

60+59+58+57+56+…….+5+4+3+2+1=1830 (Sum of months)

The short cut to calculate this is,

(Total months + 1) × (Total months ÷ 2) = Sum of all number from 1 to 'Total Months'

The same example by using the short cut,
(60+1) × (60 ÷ 2) = 1830 (Sum of months)

Step 2:

((Total month + 1) – N^th month) ÷ 'Sum of months' × Total Interest charged = Interest portion for Nth month.

Example:

For 1^st month of payment, the interest portion is:

((60+1) - 1)÷ 1830) × $12,500
= 60$ 409.836.

For 32^nd month of payment, the interest portion is:

((60+1) - 32) ÷ 1830) × $12,500 = $ 198.09

Step 3:

Now to find the 1st year interest paid by Mr. ABC's on his loan, add interest portion from month 1 to month 12.

(60+59+58+57+56+55+54+53+52+51+50+49) ÷ Sum of months × Total Interest
= Interest for first year.

So,
654 ÷ 1830 × $12,500 = $4,467

That’s 35.7% of your total interest.

As you can see, instead of paying the interest equally, you are paying the most in the first year. Let’s see the percentage of total interest you’ll be paying according to years and tenure for a loan of $50,000 with 5% interest.


What is rebate?

When you have paid fully earlier or would like to settle earlier, you’ll be given a rebate on your interest. Don’t think that you have some discounts on your interest. It’s just a term without any value used to calculate the balance you have to settle. Let me explain in the below example.

Mr. Dhandhum took a hire purchase loan of $50,000 to buy a car. He took it for 5 years with an interest of 5%. He planned to settle the loan within 3 years. At the end of 3rd year, he decided to settle his loan. What would be his total rebate? How much balance he has to pay?

His total loan is $62,500 including interest.
At end of 3rd year, his rebate would be his unpaid interest portion.
So his total rebate = Interest for year 4 and year 5.
= $1,516 + $533
= $2,049

Balance to settle loan = Total loan with interest – Total installment paid – Total rebate
= $62,500 – ($1041.67 × 36 months) - $2,049
= $62,500 – $37,500.12 - $2,049
= $22,980.88

Did you notice something? If you pay your 5 years loan in 3 years, the total interest paid is higher than a 3 year loan.

That’s all for the 1st ‘Back 2 Basic’. I’m sure some of your head already started to spin the moment the math portion came in. But, don’t worry the next ‘Back 2 Basic’ will be much easier than this. Enjoy learning.

Get ready for some mind boggling method to maximize your money. Go to Maximize Your Money: Hire purchase loan. (Coming soon)