QUOTE(Takudan @ Mar 4 2021, 02:27 AM)
Hi there,
it's my first time hearing rule 78 but on top of this, my first time hearing such a guideline i.e. do not take HP loan more than 5 years....
Now... back to the argument about stretching out your loan and getting lowest possible interest rate. I don't see that much difference between 5/7/9y loans, because either way you're paying interests mostly on the early years... what else do you have to say about this?
Appreciate your insight, thank you!
1st, you need to understand that the flat rate must be converted to effective rate to make any meaningful comparison.
And it will show that a flat rate, say 2.5%, vary very slightly in effective rates whether the tenure is 5, 7 or 9 years.
The lump sum to pay on early settlement is:
(Loan Amount less Instalments Paid) + Cost of Interest.
Let's take a step back and consider what if we pay the monthly instalments till the end of the loan tenure (i.e. no early settlement).
We will paying: All the monthly instalments. And we know that the total amount to pay back is the loan amount plus the total cost of interest.
The total cost of Interest is equal to the effective interest rate. So, if the tenure is 5, 7 or 9 years, the cost of interest we paid is about the same (i.e almost same effective rate).
The only difference from 5 to 9 years is 4 more years of paying more interest for using the loan 4 more years.
So, the question you need to ask yourself is: Why take a longer loan than necessary, say taking a 9 years loan rather than 5 years when you could easily cover the monthly instalments in a 5 years loan?
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Now back to early settlement...
The lump sum to pay on early settlement is:
(Loan Amount less Instalments Paid) + Cost of Interest.
What is the cost of interest? It is not the effective rate. The effective rate is only good if we pay instalments till the end of the loan tenure.
In early settlement, the cost of interest on using the loan for x number of months will have to be calculated.
And it is calculated using the formula in "rule of 78".
Using this formula, you can work out the cost of interest in early settlements.
Say, early settlement in year 4 in a 5, 7 or 9 years loan.
Work out the cost of interest for each and compare them first... before deciding to purposely stretching the loan further, especially when we already have in mind to trade in the car and upgrade to another one in 4-5 years time.
Lastly, also take note of the 1st part of the equation:
(Loan Amount less Instalments Paid)
In early settlement, you still need to pay the remaining balance in the loan amount. You may pay lower monthly instalments in longer loans, you still need to cough out the remaining balance.
This post has been edited by j.passing.by: Mar 6 2021, 05:30 PM