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)

When your loan app rejected...

“That stupid bank! I applied for loan and they simply reject it”, Clarisa frustrated because her loan application is rejected. She’s worried that she couldn’t get money to renovate her house as she planned. Now, she started to look around for other source of loans.

Many would have came through this, and they still confused of why their loan application is rejected. They believe that they are still eligible for the loan. They won’t give up and look for other source. Some would look for loan sharks. Some would get some third party agents. Worse thing is some people are not eligible at all and they knew it, and they use forged/fake documents to apply.

Let me tell you all something. The reason you get rejection is because there is a high chances that you won’t able to pay them promptly and risking of defaulting the loan. What does this mean? It means you have to re-evaluate your financial situation now.

If you take up the loan, the chances are high that you will end up in a deeper crisis than before. Here is a true story to prove my point.

"Peter (not his real name) doesn’t have a proper income. He wanted to get a second hand car for $10,000. He has been blacklisted by financial institute. But, he believes that by having the car he could do some business more effectively and could pay the loan promptly. So, he used his wife, Jane (not her real name) as the bait to get the car loan. Here is the worse thing. She’s a housewife. No income, nothing.

Peter got some help from his friend to get a fake payslips for his wife. Then, he applied the car loan under his wife’s name. He was proud of getting the loan. But, as time pass by, he started to default on his monthly payments. After a year or so, his car was repossessed. He tried to borrow some money from his friends and family and managed to get it. He got back his car. After a year or so, the same thing happens. He started to hide his car. Yet, the car was repossessed. Now, he has no money to get back his car.

The bank sold off the car in an auction and his wife name is blacklisted as there’s still balance of $3,000 to pay."

The moral of the story, don’t borrow or get loan when you are not eligible. You’ll just make you and your loved one suffer. Just look at the US sub-prime crisis. Why did it happen? It happened because of loosening of loan borrowing criteria. During the property boom, some of the financial institute started to give loans to people with history of bad records. As witnessed by everyone, it caused one of the biggest financial crisis in US histories.

So, when your loan application is rejected? It means something is wrong with your financial DNA. You have to sit down and find out why it is rejected. Is it because you have too many debts? Maybe your income requirement is not met? Perhaps, you have a history of bad payment? Or maybe it’s just no proper documentation.

Whatever it is, you must first stop complaining about it. Don’t try to look for other source of loan. When you are rejected, other loans would be worse for your financial health. Fix the root cause of your loan rejection.

If you have too many debts, settle them first. If you are planning to get a loan to settle your other loan, make sure your new loan offer better rates. Discuss with the bank on your plan to settle other loan. They might consider it.

If your income requirement not met, find a better paying job or take up a part time job. Or you could save some money so that you don’t have to take loans beyond your paying capability.

If you have a bad payment history, try to clear it by having at least 12 consecutive good payments, as your Central Credit Reference Information System (CCRIS) system only shows your past 12 months payment. Even thou you could just pay consecutively for 3 months and reapply, but it doesn’t mean your ‘payment due’ habit is taken care of. If your bad payment history was due to jobless issue you could show proof that you have found a job and negotiate with the bank.

Remember, your loan rejected because you are not financially sound and don’t try to get loans beyond your paying capability. You might have ‘hopes’ that you can pay them on time with your unrealistic plan, but those are just false hope. Be realistic.

Here’s another true story.

"Kevin (not his real name) was very enthusiastic when he bought his second hand Honda Civic. He managed to get a loan of $20,000. At first he tried to get the loan from banks, but his salary didn’t permit him one. So, he went to a credit institution and applied. They approved with a higher interest rate and one condition, he must have a guarantor to back him up. Since he is staying with his girlfriend, he asked her to be his guarantor. After few months paying, he started to default his payment. His girlfriend who is still studying at college had to help Kevin to pay it with her savings she saved from part time job.

Later on after almost a year, Kevin and his girlfriend break off and he couldn’t manage his financial matters. He starts to default again. Worse, he lost his job. The financial institute has to repossess the car. He was mad at it and went to argue with the staff. He ended up getting violence and arrested by the police. All this happened because he’s not qualified for the bank loan in the first place. The car got sold off at auction and whatever remaining balance has to be paid by the guarantor."

We could learn few things from here. First, the bank rejection already signaled that you will get into trouble if you get a loan. Secondly, don’t ever sign as a guarantor for a loan, especially if you are not rich enough. When financial institute asking for a guarantor, it shows the borrower’s income or history is not in good shape or didn’t meet the minimum requirement.

Some might be saying that they urgently need money; for renovation, for wedding, to buy car, to buy house, to modify car, to pamper yourself, for vacation and so on. But is it worth it to find alternate source of loan when your application rejected. Think of all the hardship and suffering. Think about thousand of people who have gone through the this.

Just delay your plan, and fix your financial leakage. Improve by learning better money management. Improve by getting a better income. Improve by fixing your bad history. Improve, improve and improve.

All in all, when your loan application rejected, it means something is wrong with your current financial situation. Fix it first before you re-apply and avoid using any shortcuts to get a loan. This is to ensure you of achieving your goals without any unnecessary risks.

The unbelievable Islamic banking loan

Almost every bank today in Malaysia have Islamic financial/banking section. Is the popularity due to the demand of customers or there is some hidden agenda behind it? That's what we are going to look at in this article. Many would be surprise once the truth is revealed.

Today we could see many are talking about Malaysia being the No.1 Islamic financial hub in the world. It is something we all should be proud of. Yet, many still do not know how it actually works. Many assumes since its Islamic, it means the rates should favor the people and not the bank. Many thinks it's a pure form of investment. Yet, there are something in it which everyone should be watching out for which could diarrhoea your money. Here is why?

Conventional loan uses principal or balance reducing method to calculate your interest. This means that the interest is charged based upon your principal balance every year. The principal will reduce whenever you make a payment. Every time you make a monthly payment, you are actually paying interest and reducing the principal with whatever left after paying interest. So, making extra payment to your loan at any times would definitely reduce the total interest charged as your principal is reduced.

Islamic loan is calculated exactly like your car hire purchase loan. The interest (even thou that's not what they are calling it;they call it profit rate) is charged on the borrowed principal amount times the number of years up front. What does this mean? It means you are paying a lot more interest on your loan. Not just that, paying any additional payment amount will not reduce your total interest as it's already charged up-front, even thou they have some rebate when you have finish paying your loan earlier. But, the rebate is useless as the bank have already charged most of the interest at the beginning. I will write another article on this in near future and how to deal with it.

Here are some illustrations to compare conventional loan and Islamic loan.


Check out this table to make comparison between conventional loan and Islamic loan.


No wonder all banks, including those foreign origin such as HSBC and Standard Charterted are rushing to open Islamic financial service. The amount of profit they could earn is unbelievable. They could earn double compared to conventional loan. This is really unfair to the people. By right they should be charging less than 5% for Islamic loan to make it equivalent to conventional loan. Let's see what is the true effective interest rate for the Islamic loan. Hope nobody will get heart attack after looking at the figure.

A 5% interest (profit rate) for a 10yrs Islamic loan is equivalent to.... Roll the drum...
Yes, my friend. There's nothing wrong with your eye. It is 29.97%. FYI, just like a hire purchase loan, the shorter your loan tenure the lower the effective interest rate, and the longer the tenure the higher the effective interest rate. So, just imagine those who have taken Islamic housing loan 30 years. They would be paying through their nose.

Who's fault is it? Is it the religion itself at fault? No, my friend. It have nothing wrong with the religion. It's the greedy corporate trying to suck all the money out of you by showing innocent faces at you. There is nothing wrong with the concept. They just need to charge a lower profit.

So, is all Islamic loan have disadvantages? There are some advantages of Islamic loan. But, the disadvantages outweigh advantages. Here are the advantages:

1. If your payment overdue, there are no late payment penalty charges.
2. Even if you overdue, there are no additional interest charged on the overdue amount. They would only charge accordingly.

Btw, there was another disadvantages until the court overruled it in Affin Bank Bhd vs Zulkifli Abdullah case. Check out this links for more details:

Call For More Transparent Islamic Banking Documents
Affin Bank Bhd vs Zulkifli Abdullah

How about from tax planning point of view? Islamic loan is still at disadvantage, as they are calling it as profit rate and not interest rate. So, too bad if you have invested in a property by securing an Islamic loan. You can't do any interest rate deduction from your rental income.

So, friends.. Until the profit rate is reduced to a acceptable rate, Islamic loan is a big NO NO.