Sunday, 12 Jul 2020 l 10:00 AM MYT
I write to highlight something very important to consumers, especially hire purchase borrowers. I recently underwent an unpleasant experience when I looked into early settlement of such a loan from a local bank.
The silver lining of the experience is that I managed to gain knowledge on how perhaps we have been duped by the financial industry without our knowledge. This new “wisdom” that I gained is about the “Rule of 78”.
In 2014, a letter from a consumer organisation published by The Star pointed out that the Rule of 78 practiced by the banking industry for small loans is recognised as unfair practice – “it has been abolished in the United Kingdom since 2005” ("Stop using Rule of 78 for loans, banks urged").
I am surprised that an issue as important as this to borrowers and consumers was then allowed to disappear from the public’s radar without action by the authorities.
This matter impacted me pertaining to a hire purchase transaction I entered into in 2013. I bought a car as a gift for my sister. Being an existing customer of the bank and finding it convenient, I was persuaded to take a hire purchase loan from it.
Considering this was a gift, I chose the longest hire purchase period – nine years – with clear emphasis that I may want to settle it early and would expect a rebate on the annual interest rate for early settlement. The bank officer assured me this is standard practise.
The amount of loan that I took was RM56,500 and, based on an interest rate of 2.86% a year, I would be paying RM1,615.90 in interest a year. Multiplied by nine years, that meant I would pay RM14,543.10 in total. This total interest amount added to the loan amount meant I owed the bank RM71,043.10.
This full loan amount was then divided over a period of 108 months (ie, nine years), which meant I had to pay RM658 a month over 107 months plus RM637.10 for the final month.
As I planned to settle the loan before the nine-year period, I paid RM700 a month instead of RM658 as per the contract. After making payments without fail, at the end of June 2020 – more than two years before the end of the hire purchase term – the amount outstanding for my loan stood at RM5,000.
Towards the final quarter of 2019, I requested for a settlement amount so I could pay off whatever amount was outstanding but the bank was not responsive. I even requested assistance from my personal banker and still did not get any response. When the movement control order (MCO) was imposed in March, I did not pursue my request. However, as soon as some of the MCO restrictions were lifted in June, I followed up with the bank and on June 29, I received the “Confirmation of HP/IP Settlement” from the bank.
To my disbelief, the “rebate” given for settling the loan two years in advance was merely RM681.94. This amount is way below even one year of interest (2.86% x RM56,500 = RM1,615.90). I sought an explanation and was told that the calculation for the rebate is not straightforward as the calculation for the interest because it is based on the Rule of 78.
It seems that this rule allows banks to allocate pre-calculated interest charges that favour banks over borrowers for short-term loans or if a loan is paid off early. The Rule of 78 methodology gives added weight to months in the earlier cycle of a loan, so a greater portion of interest is paid earlier.
Some may say that this is a commercial transaction and if a borrower agrees to take on the loan, the borrower then is presumed to agree to the usage of Rule 78. I totally disagree in this regard, as I should have the right to be informed of this unfair rule and practice by the bank and should be given the right to decide. This was never communicated to me and like any reasonable consumer, I had rightfully concluded that any rebate given for early settlement would be based on the flat rate of interest per annum, in this case at 2.86%, equivalent to RM1,615.90 per annum.
Having been made aware of this formula – which I believe many are unaware of and would have been “deceived” by over the years – I was shocked to discover that countries like Britain and various states in the United States have outlawed the Rule of 78. Why is Malaysia allowing this rule to be practised by our banks? At the very least, why are banks not clearly highlighting the rule to consumers before they sign a hire purchase agreement?
I fully understand the need for lenders, in this case being huge profit-making financial organisations, to make money. For these lenders their profit comes from the annual interest rates. In the case of hire purchase contracts, borrowers are informed that they are charged flat interest rates per annum for the duration of the loan. In the case of early settlers the rebate should be calculated using the same formula. But whatever the method the banks use, it is the responsibility of the bank to explain it clearly to the consumer from the onset.
Nevertheless, I strongly believe that the Rule of 78 is oppressive towards borrowers and should at least be restricted in its usage. Britain, the United States and other developed economies recognise this. Why not Malaysia?