Recently I overheard a person who decides to borrow a personal loan from bank to invest on ASB ( Amanah Saham Bumiputera) trust fund. According to this person, the lowest interest rates for Bank Islam Personal Loan is around 3.25% p.a. while ASB investment provides a hefty 6% return. This person claims that he’s making 6% – 3.25% = 2.75% by leveraging on bank’s money. Is this the case ?
To really understand how personal loan interest works, we must dig deep into how personal loans interest is calculated in Malaysia. Typically, a bank or financial institutions imposes a Flat Interest Rates structure when calculating interest for car loans and personal loans. What Flat Rate is exactly ? This basically means that initial sum of money borrowed will always be used to calculate the interest rate for the entire tenure of the loan. I’m not gonna explain much as there are plenty of resources on how a Flat vs Effective interest rates works such as here. Although the advertised interest rates seems much lower, the EIR(Effective Interest Rates) of this loan could be nearly as double as compare to reducing balance interest rates.
As a rule of thumb, the conversion from flat interest rates is nearly double effective interest rates. The figure sits around 1.8. So this persons borrows at 3.25% p.a x1.8 = (EIR) which sits around 5.85 % p.a. Of course there comes the extra charges such as RM50 Wakalah fees and Stamp Duty which sits around 0.55% of the personal loan. Additionally you must purchase also additional products such as BancaTakaful and Will Writing from Bank Islam to enjoy the lowest interest rates. So how much does this person really earns from the leverage ?
The moral of the story is, always understand how Interest Rates works for certain type of loans before making decision based solely on the figure. Fortunately, most banks are required to display their EIR (Effective Interest Rates) besides from what you see in the brochures of the loan. Just dig deep into the product disclosure sheet where the EIR will be displayed.