Understanding Loans

Getting a good point of view from Malaysia’s Credit Counseling and Debt Management Agency is by far one of the best ways to make you a better financier. MHL couldn’t stress this enough, and it’s vital to a more sound, financially stable life.

Be WISE, MHL readers. Do your job and save your own skin. Understand loans before you proceed to the bank and take another loan.

Credit Counseling and Debt Management Agency

What are the Main Components of a Loan?

All loans, whether it is a car loan, home loan or personal loan, consist of three main components: The interest rate, security and term.

The Interest Rate

The interest rate is the lender’s charge for the use of their money. The interest rate is usually expressed in terms of a percentage of the amount loaned on a per annum (p.a.) basis. The interest charged is mostly on a compounding basis (i.e. interest-on-interest) and could be either on an annual/ monthly/ daily compounding basis (another term used is yearly/monthly/ daily rest.)

There are two different types of interest rates: fixed or variable.
Fixed rates are just that: fixed and unchanging. If your fixed interest rate is 6% p.a., it will be 6%p.a. for the entire tenure of the loan.Variable rates can change over time and are usually pegged on a standard market rate, such as the Base Lending Rate, BLR (current BLR = 6.30%). For instance, you may take out a loan with a variable rate at BLR + 1%. This means that you’ll pay one percent more than the BLR, or a total of 7.30% p.a.

The Security

All loans are either secured or unsecured. This refers to whether the lender requires you to put up assets, often referred to as collateral, to secure your loan. If you have a secured loan, it means your lender will be able to resort to foreclose the collateral in the event you default on the loan.

Because there is an exit repayment alternative, interest on secured loans are lower compared to interest on unsecured loans. When you finance the purchase of your car through a bank loan, you’re actually a hirer (not owner) of the car you’re driving until you’ve fully repaid your loan! Similarly, in the case of a housing loan, the bank will have an ‘ownership claim’ on the house until you have fully repaid the housing loan. In an unsecured loan there is no collateral that the bank can foreclose in the event of default.

Given this risk, unsecured loans almost always have higher interest rates than secured loans. In order to mitigate their risk, Lending institutions sometimes require that an additional person co-sign for unsecured loans, or guarantee the loan amount.

The Term (of a loan)

The term of a loan is the length of time that the borrower has to pay back the loan. Most personal/ car loans have terms of 3 to 9 years whereas home loans stretch much longer and can typically, up to 30 years! The term is the maximum length of time the borrower has to repay their loan; loans can be paid off before the term is up (but there may be penalties for early settlements)

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