As the economy recovers from the coronavirus pandemic, governments from around the globe, including Singapore, are doing what they can to keep interest rates from rising. For instance, the Federal Reserve kept interest rates near zero through 2022.

In Singapore, the interest rate is expected to be 0.40% by the end of the quarter. Interest rates are determined by central banks and will fluctuate depending on different factors. With the economy as it is, interest rates are kept low so loans become more affordable and consumers and businesses are encouraged to borrow. 

Are you looking to borrow but are intimidated by the different interest rates? Here’s a guide on how interest rates work and the factors affecting them. Plus, a few tips on how to calculate loan interest.

Refresher:

What Is Interest Rate?

When taking out a loan, you’re not just going to pay back the money you borrowed. You’ll also be paying an additional sum, known as interest.

Interest rate is the percentage that a bank, financial institution, or lender charges for the loan. This is the price you pay for borrowing money. How much loan interest you’ll be charged is determined by different factors, including credit score, income, loan amount, and loan terms.

When it comes to loans, there are two types of interest rates:

1. Advertised Rate

Also known as the nominal rate, it is the loan interest rate before taking inflation into account. There are two types of interest rates that banks or licensed moneylenders refer to:

  • Flat rate: This type of loan interest rate stays constant throughout your loan tenure. This is usually used for car loans and personal loans.
  • Monthly rest rate: This interest is calculated based on the outstanding balance of your loan. So as your balance reduces, the interest amount will also decrease. A monthly rest rate is usually used on home loans.

2. Effective Interest Rate (EIR)

EIR for short, this interest rate takes into account other fees, such as processing fees. Plus, it takes into account how long the loan tenure is and the frequency of the repayments. This is because it takes into account the compounding effect.

That said, the EIR reflects the true cost of taking a loan in Singapore. So, a lower EIR means a more affordable loan. When comparing different loan packages, use EIR to get a full understanding of the true cost of each loan option.

Floating Rate: These interest rates are pegged to a board rate, such as SIBOR or SOR rates. It fluctuates on a daily basis. Loans with floating interest rates may come with or without lock-in periods.

This type of rate is favourable if:

  • Interest rates are predicted to fall
  • You have a thorough understanding of how the home loans market works and will monitor the SIBOR or SOR rates occasionally.

Fixed-Rate: This is the opposite of the floating rate. Fixed interest rates will remain the same throughout the lock-in period – ranging from 1 to 5 years. When the lock-in period is over, the fixed rate will become a floating rate and will be pegged to a board rate.

This type of rate is favourable if:

  • Interest rates are on an upward trend
  • You’re paying monthly repayments in cash
  • You prefer to have predictable and consistent monthly repayments

How Interest Rates From Banks Are Calculated

Why do you need to know how to calculate loan interest? To know how much you need to pay for your monthly payments. This will help you determine if you can afford it.

In Singapore, car loans or personal loans use a flat rate. This means the interest rate stays the same throughout your loan tenure. To calculate the interest, use this formula:

interest rate / number of payments x principal = monthly interest amount

To illustrate, say, you have a car loan principal of S$75,000, loan tenure of 5 years, with an interest rate of 2.5% p.a., and a monthly repayment schedule.

(0.025/12) x 75,000 = 156.25

You’ll be paying S$156.25 interest per month.

Payments5-year loan
Monthly paymentsS$1,406.25
Total amount paidS$84,375
Interest paidS$9,375

You can use a spreadsheet to automate the calculation. However, banks or lenders may calculate the loan in a different way. So check with them to get a more accurate figure.

How Interest Rates From A Licensed Moneylender Are Calculated

If you’re thinking of taking out a loan from a licensed moneylender in Singapore, you will be charged with an interest rate of up to 4%. This cap applies regardless of your income and whether the loan is secured or unsecured.

To illustrate, say, you have a personal loan principal of S$2,000, loan tenure of 1 month, at an interest rate of 3.92%. Your total interest is S$78.40.

However, licensed moneylenders may use a different formula. So check with their loan officer to get an accurate figure.

Factors That Can Affect How Much Interest You Pay

Loan Amount

The bigger the amount you borrow, the higher the interest you’ll pay. This is because the lender is assuming bigger risks and so they want a higher return. That said, borrow only the amount you need.

To illustrate, let’s say you borrowed S$10,000 over five years with a 2.5% interest rate. You’ll be paying a total interest of S$1,250. If you borrow S$20,000 and keep all the other loan factors, you’ll pay a total interest of S$2,500.

Interest Rate

When calculating the total cost of a loan, the interest rate also plays a major role. And there are different factors that can affect interest rates. For instance, a low credit score can lead to a higher interest rate.

To illustrate, let’s use the same factors as the previous example – S$10,000 loan amount, 5-year term, and amortized loan.

Payments2.5% p.a.4% p.a.
Interest paidS$1,250S$2,000

Plus, you’ll need to determine what type of interest rate is used for your loan. For instance, a floating interest rate means a rise or fall in your interest costs over the course of your loan tenure.

Loan Term

You also need to take into account how long you’ll be paying for the loan. Shorter loan terms mean higher monthly repayments. However, you’ll incur less interest and save money in the long run because it is short-term.

A longer loan term, on the other hand, will help you stretch out your payments. But it will also significantly impact your interest costs over time. 

To illustrate, here’s a comparison between a 5-year loan tenure and 7-year loan tenure, using the same loan factors as above (S$10,000 loan amount and 2.5% p.a. interest rate)

Payments5 years7 years
Interest paidS$1,250S$1,750

Repayment Schedule

How often you pay the loan will also affect the interest on a loan. Making frequent repayments will reduce the outstanding balance of your loan. So, in case a lender charges compounding interest, paying more often will help you save interest in the long run.

Repayment Amount

How much are you required to pay every month? As previously stated, repaying the loan more often will potentially save you money on interest because you’re reducing the outstanding balance of your loan. That said, paying higher amounts every month will have the same effect.

If you’re planning on increasing the repayment amount to your monthly loan payment, make sure that the extra funds will be deducted from your principal balance. If that’s the case, then this strategy will lower your debt and lower the total amount of interest.

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How To Calculate The Total Repayment Amount

Now you know how to calculate the total interest amount. Aside from that, you also need to understand how to calculate your total repayment amount. 

Here’s a simple formula:

Principal amount + total interest amount + any additional fees for loan = total repayment amount

Banks and lenders may charge different fees and charges. So keep those in mind as they will add to the total cost of the loan.

Feeling overwhelmed by all these formulas? There are personal loan calculators available online. In fact, most major banks have their own loan calculators on their websites to help you get a ballpark figure at your fingertips.

How To Get The Best Loan Interest Rates

Improve Your Credit Score

Your credit score in Singapore is a statistical derivative based on your credit history. You can obtain a credit report from the Credit Bureau of Singapore (CBS) for a fee of S$6. 

A high score will demonstrate your credit trustworthiness. That said, banks or lenders are more likely to give you lower interest rates, higher loan amounts, or longer loan tenure.

Here are a few tips to improve your credit score:

  • Make sure to repay your existing debt on time
  • Never default on your loans
  • If possible, you shouldn’t have too many facilities open
  • Avoid making multiple loan enquiries in a short time
  • Consolidate your debt and make repayments to repair a damaged credit score

Choose A Shorter Repayment Timeline

Shorter loan terms usually mean higher monthly payments, but it also often means lower interest rates. In fact, you’ll be paying less interest than a longer-term loan. That said, if you can afford the higher monthly payments of a shorter loan, it’s a good option to consider.

Meet Total Debt Servicing Ratio Requirements

Take the necessary steps to make sure that your total debt servicing ratio (TDSR) meets the requirements. The TDSR framework in Singapore helps ensure that borrowers will not take on more debt than they can handle. The goal is to issue loans to borrowers who can afford them.

That said, TDSR limits the total amount you can borrow. Plus, it will also affect your loan quantum and interest rate. TDSR ensures that your monthly payments account for less than 60% of your income.

What if you can’t meet the TDSR requirements?

You can either make a bigger down payment, opt for a longer loan tenure, or choose to buy a cheaper house. But there are other steps you can take:

  • Tell your bank about other sources of income, bonuses, or commissions you’ve earned
  • If you’re renting out a property, inform your bank of any rental income
  • If you’re borrowing with another individual, exclude them if they hold too much debt.

Other Costs Of Loans To Consider

When taking out a loan, you will not only incur interest but additional fees and charges as well. These costs can add up to the total cost of the loan. So keep these factors into account when doing your calculations.

  • Processing Fee: Also known as an administrative fee, this is usually charged upfront upon loan approval.
  • Amendment Fee: This is charged when you make changes to the original loan application.
  • Cancellation Fee: You will pay a fee if you change your mind after accepting the loan terms.
  • Excess Charges: When you draw more than the original overdraft limit, you’ll be paying excess charges.
  • Late Payment Charges: If you fail to make payments upon the due date, you’ll be charged with late fees.
  • Default Charges: This is charged for failing to make payment.
  • Early Repayment Charges: In case you decide to pay the remaining loan balance earlier than the agreed loan tenure, you’ll also pay for early repayment fees.

How To Compare Loan Terms

Knowing how to calculate the interest on a loan will help you in making smart financial decisions. That said, you need to take your time in comparing loan packages. With different loan terms and monthly payments, finding the right one requires some effort. Aside from interest rates, there are other factors you need to consider.

Loan Tenure

When comparing different loan packages, determine whether they have a flexible loan tenure. Some borrowers may prefer longer loan tenure to stretch out the loan and pay lower monthly repayments. However, this also means paying more interest in the long run.

That said, consider choosing a shorter loan tenure – if you can afford the monthly repayments. This will lower the amount of overall interest. However, if a shorter term comes with a higher interest rate, then choose a longer-term loan but make larger repayments.

Total Cost Of The Loan

Consider the principal loan amount plus interest and additional fees. The total cost of a loan is the sum of interest payments, processing fees, and other charges you pay throughout your loan tenure.  If you don’t make late payments or early payments, this is the amount you’ll end up paying to the lender.

Monthly Payment

Lastly, look at how much you’ll need to pay every month. Determine whether you can afford it and if you’re not stretching yourself financially with an interest-only loan payment. 

To calculate your monthly payment, use this formula:

Principal loan amount x annual flat rate x loan tenure = total interest

Multiply your annual flat rate by your principal loan amount. Then, multiply it by the duration of your loan in years. This will give you the total interest you’ll need to pay throughout the loan term.

Then, add this amount to the principal you borrowed. Lastly, divide the amount by the duration of the loan in months. The result will be your monthly payment.

(Principal amount + total interest) / loan tenure in months

In general, choose a loan with the lowest interest rate and a shorter loan term, as long as you can afford the monthly payment.

Conclusion

  • Taking out a loan means paying it with interest.
  • How much loan interest you’ll be charged is determined by different factors, such as credit history, income, loan amount, and loan terms.
  • You pay more interest for a loan with a longer loan tenure than for a short-term tenure.
  • Banks and lenders may use a different formula for calculating interest on a loan. Use a loan calculator to automate the calculation.

Before taking out any type of loan, you must also take into account the amount of interest you’ll be paying. On top of that, you’ll also pay for processing fees and other charges. So be smart about the loans you take out.

Use the formula given above to calculate interest on a loan or use a personal loan calculator. In doing so, you can plan and manage your expenses effectively.

If you’re looking for an affordable loan, Fortune Credit is one of the leading moneylenders in Singapore. With personal loans, foreign loans and business financing available they are sure to have something that’s right for your needs! Take advantage of their free quotes by filling out the loan form online or call them directly at 6777 1887.