Compare an instalment loan, a credit line and a balance transfer for the same need, using EIR and total cost.
Aisha needs to raise S$10,000 to pay her father's dental bill. She has three borrowing options on her phone, each described in a different way, and on the screen they look impossible to compare.
The personal instalment loan is quoted as a flat rate, the credit line as a yearly rate plus an annual fee, and the balance transfer as 0% plus a percentage fee. Quoting in different terms makes the offers hard to put side by side, and lenders benefit from that confusion. The fix is to express all three in the same units: total repaid and EIR over the same period. Aisha's figures below are made up, chosen to show the method, and when you do the exercise yourself you should use real offers.
Her siblings will repay her over about a year, so Aisha compares everything over a 12-month period. Each product repays differently, so for each one she decides how she would actually use it over those 12 months and models that.
The instalment loan is 3.5% flat for one year, with a S$100 processing fee. A flat rate is charged on the full amount borrowed for the whole term, which makes it different from a rate charged on the reducing balance, where interest falls as you pay the debt down. The flat interest is S$10,000 x 3.5% = S$350, and each monthly instalment is S$10,350 / 12 = S$862.50. Adding the S$100 fee brings the total to S$10,450. Using the EIR calculator from lesson 3.4 of "How money works: banks, interest, inflation and risk", "Calculate the EIR of a flat rate offer with the RATE function", the EIR comes out at about 8.3%.
The credit line charges 20% a year on the reducing balance, with a S$100 annual fee. It has no fixed repayment schedule, so Aisha models it as repaid in equal monthly payments over the 12 months, because that is the only fair comparison with a one-year loan. In a spreadsheet, =PMT(20%/12,12,-10000) gives about S$926.35 a month. Repaid over 12 months, that is about S$11,116, and with the S$100 annual fee the total is about S$11,216. Counting the fee, the EIR is about 22%.
The balance transfer is 0% for six months with a 3% fee, which is S$300 on S$10,000. After that, an example rate of 26% a year applies to whatever is left. Aisha pays a twelfth of the balance each month, S$833.33, for the first six months. That clears S$5,000, so when the six months end she still owes S$5,000, and it moves to the 26% rate. To clear it over the remaining six months she would pay about S$897.66 a month, from =PMT(26%/12,6,-5000). Interest over those six months is about S$386, so the second half costs about S$5,386 in total. The full cost is S$300 fee + S$5,000 in the first six months + about S$5,386 in the second six months = about S$10,686. The payments are uneven, so she uses the IRR function on the monthly cash flows to get the EIR, which is about 12.6%.
Many people get caught when their need runs longer than a balance transfer promotion, because the product does not fit that need. If Aisha had left out the post-promotion rate, the balance transfer would have looked like it cost only its S$300 fee.
By total repaid, the loan comes first at S$10,450, the balance transfer second at about S$10,686, and the credit line third at about S$11,216. By EIR the order is the same: about 8.3%, 12.6% and 22%. Different figures can produce a different order, so check both rankings when you use your own offers.
The length of your need affects which product wins. Lesson 3.2 showed that a shorter need favours the credit line. A need you can clear inside the promotional period favours the balance transfer, where the fee might be the only cost.
Aisha also writes one main risk beside each option. For the instalment loan, it is the fixed commitment, plus the early repayment charge if her siblings repay her faster than expected. For the balance transfer, it is the jump to the full rate at month seven, and the temptation to put new spending on the card once it has been cleared. For the credit line, nothing forces the balance down, so a slow month or two quietly makes it the most expensive option by an even wider margin.
Allow about 30 minutes for the exercise. Start by choosing a realistic period for your own need. Then go to bank websites and find one current personal instalment loan, one credit line and one balance transfer. For each offer, record:
the date you checked it, because rates and promotions change the quoted rate, and whether it is flat or on the reducing balance the EIR, if the bank shows it every fee: processing, annual, transfer and early repayment for the balance transfer, the promotional period and the rate afterwards any minimum term
Next, model each offer over the same period. Run the instalment loan through your EIR calculator from lesson 3.4, which uses the RATE function. Model the credit line as equal monthly payments with PMT, then add the annual fee. For the balance transfer, work out what is left when the promotion ends, apply the post-promotion rate, use PMT for the remaining months, and run IRR on the uneven monthly cash flows to get the EIR.
Then add the costs people usually leave out. Include the rate after any promotion ends. Add fees that apply only in some cases, such as an early repayment charge, if there is any chance you will repay early. If you would keep a credit line open after clearing the balance, note that it may still charge an annual fee every year.
Finally, rank the three by total repaid, check the EIRs against that order, and write one main risk beside each option.
Build a comparison with three columns, one per option, and rows for the date checked, quoted rate, EIR, every fee, monthly payment, total repaid and main risk. Work out the totals and EIRs over the same period for all three. Below the table, write one sentence saying which option you would choose for a 12-month need and the reason. You are using offers you found yourself, so your order may differ from Aisha's, and the reason you write should be your own.
Fill in the comparison table for all three options. Then write which one you would choose for a 12-month need, and why.
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