Cost Of Taking Out A Loan: Different Types Of Interest Rates

Taking up a loan in Singapore? Before you assume that taking a fast loan in Singapore is as straightforward as borrowing a sum of money and then repaying it, think again. A legal loan in Singapore will require you to pay interest and processing fees – this means you’ll have to repay more than what you initially borrowed.

Just like how a licensed moneylender can charge up to 4% in interest per month, other financial institutions can also charge varying amounts of interest on your loan. How much you end up repaying depends on the types of interest rates used and how they are calculated.

Read on to find out the common types of interest rates in Singapore that you need to take note of.

1. Fixed Interest Rate

This is a common type of interest rate used on loans in Singapore. As the name suggests, the interest is fixed throughout the repayment period. The upside for such an interest type is that it does not fluctuate over the loan period hence allowing borrowers to have an accurate estimation of the repayment amount. On the downside, the fixed interest rate is usually higher than the variable interest rate because it is hedged against external factors that might increase the interest over time.

2. Variable Interest Rate

A variable interest rate, also known as floating rate, is an interest that adjusts over time in response to changes in the market. When the underlying benchmark rate or index rises or falls, it affects the variable interest rate paid by the borrower. For example, when it comes to legal home loans in Singapore, the variable rates are usually tagged to Singapore Interbank Offered Rate (SIBOR) or Fixed Home Rate (FHR).

An advantage of such an interest is the possibility of getting a lower rate should the underlying index decline. Conversely, if the underlying index rises, the interest rates might increase too.

3. Simple Interest Rate

A simple interest rate simply means a fixed interest rate of a principal amount to be paid over an agreed period. For example, when a couple decides to take up a S$10,000 fast loan in Singapore to fund their wedding from a licensed moneylender at an interest of 4% and repayable within a month, the interest charged is simply 4% of the loan amount.

The calculation for loans that are based on such rates is very basic and is generally expressed with straightforward multiplication of principal amount, interest rate, and the period agreed.

4. Compound Interest Rate

Compound interest is the addition of interest to the principal sum of a loan when it is not repaid. The methodology is called interest on interest. To understand this, think of a loan balance as two key components – the principal amount and the interest incurred from the loan. The lender will apply the agreed interest on the loan balance and the interest incurred to calculate the subsequent year’s interest payment

To illustrate this, let’s use an example of a S$10,000 loan in Singapore at 10% interest per annum. If the loan is not repaid by the end of the first year, the total amount owed would be S$11,000. At the end of the second year, the new balance would be S$12,100. The S$1,000 of interest incurred in the first year has incurred its own interest of S$100!

While compound interest can be a good thing for earning on deposits, it is not the same if it is used on loans. Compound interests can get expensive for borrowers and when a loan is not well managed, they can end up owing a lot more money than they initially intend to.

5. Effective Interest Rate

An effective interest rate (EIR) is the true cost of taking a loan in Singapore, taking into account the compounding effects over time. The cost depends on how long your loan tenure is and repayment frequency, as well as the number of instalments.

Typically, effective interest rates are higher than advertised interest rates. This is because advertised interest rates only consider the interest you are supposed to be paying. For example, if you are taking a $2,000 loan at 10% p.a. Interest, you are expected to repay $200 in interest annually. But EIR considers other factors such as processing fees, hence you could end up repaying more than that.

6. Reducing Balance Rate

Also known as the diminishing balance rate, the reducing balance rate only charges interest on your loan’s remaining balance. This effectively reduces your interest repayment each month as you continuously pay off your principal loan amount. This is perfect for lengthy loan tenures as you save more over time.

Here is a simple formula for calculating your payable interest following the reducing balance rate:

Interest amount per instalment = Effective interest rate per instalment x Outstanding loan amount

7. Annual Percentage Rate

The Annual Percentage Rate (APR) is an annual rate charged for a loan in Singapore and is widely used for most financial solutions – from mortgages and car loans to credit cards. So how does it work?

Every time you take out a loan, there is a cost involved which is the interest, which ultimately adds up to the total loan cost. Every month, you are essentially paying a portion of the principal loan and a portion of the interest.

Two types of APRs can be applied – fixed and variable. A fixed APR means the rate remains the same throughout the entire loan term, while a variable APR means fluctuations. APRs can change anytime according to market variability and the borrower’s ability to repay on time, however, lenders are required to provide advance notice on the change and why.

The annual percentage rate considers all other borrowing costs such as administrative and late fees, however, it does not account for the compounding effect of interest. So, when looking for a legal loan in Singapore, between two offers that present the same nominal rate and monthly payments, choosing the loan package with a lower APR will usually require lesser upfront fees and offer a better deal.

Conclusion

Understanding the different types of interest rates can be complex, this is why it is important to find a licensed moneylender who can provide reliable advice and competitive rates when you need a loan to fund your projects. At Galaxy Credit, we offer a wide selection of loans such as personal loans and business loans. Contact us for a free consultation now.

About the Author

Constance Lee

Constance Lee is a freelance writer who is experienced in creating well-researched content for many industries. She has worked with many clients across the world and has produced over 500 articles.