You will be able to read a loan offer and say which rate it quotes and what that rate leaves out.
You are walking past a car showroom and the banner says financing from 2.5% a year. A bank's app offers you a personal loan at 3.8% a year, and in smaller print, EIR 7.2%. Your home loan letter says 3.1%. Three loans, three percentages, and it is natural to line them up and think the car loan is cheapest. That comparison is almost certainly wrong, because the three numbers are not measuring the same thing. All three figures here are made up for the example.
This lesson teaches you to read which rate a loan offer is quoting, and what each kind leaves out. The next lesson does the arithmetic.
A flat rate is charged on the original loan amount for the whole term, even though you pay the loan down every month.
Borrow S$10,000 at 3% flat for five years, and the interest is S$10,000 times 3% times 5, which is S$1,500. You repay S$11,500 in sixty equal instalments. The catch is in the first sentence. Halfway through the term you have repaid half the loan, yet you are still paying interest as if you owed the full S$10,000. You are paying for money you no longer have.
Flat rates are common on car loans and many personal instalment loans. They look low because they are calculated on a figure that shrinks every month while the interest does not. Lesson 3.2, Why a flat rate loan costs nearly double what it looks like, works through exactly how much this understates the cost.
The alternative is a rate charged on the reducing balance, where each month's interest is worked out only on what you still owe. Home loans in Singapore work this way. As you repay, the interest portion of each instalment falls. A 3% reducing-balance rate and a 3% flat rate are very different prices.
APR stands for annual percentage rate. It is a yearly rate that may fold some fees into the cost, depending on the lender and the market. It is common in the US and UK, and you will see it in some advertisements and comparison sites.
APR has a limit you should know about. It usually treats the year as a single block and ignores the effect of compounding within the year, which you met in lesson 2.2, Monthly compounding beats yearly at the same stated rate. On a loan repaid monthly, that makes the APR a little lower than the true yearly cost. What counts as a fee inside an APR also varies, so two APRs may not include the same charges.
The effective interest rate, or EIR, is the rate that makes the money you receive equal to the payments you make, taking into account when each payment happens. It reflects three things the other numbers can miss: that you owe less after every payment, the timing of the payment schedule, and fees that come off what you receive.
Because the EIR puts every loan on the same reducing-balance footing, it is the one number that lets you compare a flat rate car loan with a personal loan with a credit line. In the showroom example, the 2.5% flat car loan would carry an EIR close to double its headline, and could easily cost more than a loan advertised at a higher rate on a reducing balance.
EIR is also the number Module 3 keeps returning to. In lesson 3.4, Calculate the EIR of a flat rate offer with the RATE function, you will build a spreadsheet that works it out from any offer.
Lenders in Singapore usually show the EIR somewhere in a loan offer, often next to the headline rate in smaller type or in the product summary and terms. If it is missing, ask for it in writing before you sign. A lender can tell you the EIR of any instalment loan, because it is just a calculation on the loan amount, the fees and the payment schedule.
When you read any loan offer, ask two questions. First, what kind of rate is the headline: flat, reducing balance, APR or EIR? The words "flat" or "p.a. flat" are a strong clue, and so is a rate that looks low next to a much higher EIR. Second, is an EIR shown, and where? The detail of specific loan products, such as card debt, BNPL and car loans, belongs to the course Credit and debt: scores, cards, loans and BNPL.
The best way to get comfortable with this is to see it in real offers. Loan advertisements are everywhere: bank apps, car showrooms, the backs of buses, your inbox. The next two you come across are your material.
Collect two loan offers or advertisements and write down which rate each quotes in the headline and whether an EIR is shown.
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