Flat rate vs effective rate: why the same loan has two interest rates

A loan advert may quote one rate while the agreement implies another. Neither is wrong. They measure different things, and knowing the difference lets you compare loans properly instead of being caught by the smaller number.

How a flat rate works

Under a flat rate, interest is worked out once, on the full amount you borrow, for the whole tenure. The total is then spread evenly across the instalments.

Take MyOneCredit's rate of 4.88% a year on RM 10,000 over 60 months:

• Interest: RM 10,000 × 4.88% × 5 years = RM 2,440
• Total repayable: RM 10,000 + RM 2,440 = RM 12,440
• Monthly instalment: RM 12,440 ÷ 60 = RM 207.33

Every instalment is the same size, and the interest does not change if you pay on time. That predictability is the point of a flat rate: you know the total cost on day one.

Why the effective rate is higher

Each instalment repays part of what you borrowed. After a year of paying RM 207.33 a month you no longer owe RM 10,000, yet a flat rate still charges interest as though you did. The effective annual rate asks a fairer question: given what you actually owe each month, what yearly rate are you really paying?

For the example above, the answer is about 8.95% a year. That is the rate a reducing-balance loan would need to charge to produce the same RM 207.33 instalment.

The same 4.88% flat, at every tenure

Because the effective rate depends on how quickly you repay, it changes with the tenure even though the flat rate does not.

All rows are for RM 10,000 at 4.88% flat. Read across a row and you see the trade-off: a longer tenure buys a smaller instalment at the price of more interest in total.

Flat versus reducing balance, side by side

Suppose two lenders both say "5% a year" on RM 10,000 over five years, but one means flat and the other means reducing balance.

The same "5%" costs almost twice as much under one method as the other. This is why a flat rate should never be compared directly with a bank's reducing-balance rate.

How banks and moneylenders quote

Banks usually quote personal loans as a flat rate too, and are required to show the effective rate alongside it. Credit cards charge on a reducing balance, compounded monthly, at rates that are typically far higher than a personal loan's flat rate. Licensed moneylenders quote a flat rate in the agreement itself, and the law caps it: no more than 18% a year for an unsecured loan and 12% for a secured one.

Source: Attorney General's Chambers of Malaysia · Moneylenders Act 1951 (Act 400)

The law behind the rate

Two rules in the Moneylenders Act 1951 protect you here. Section 17 forbids compound interest: interest may not be charged on interest. Section 17A sets the caps above. Together they mean that the rate written in your agreement is the rate you pay, and it cannot grow.

The only interest that can be added later is simple interest of 8% a year on an instalment that is overdue, counted day by day on that instalment alone. Our agreement explained page shows the exact clause and lets you work the figure out yourself.

Which figure to compare

• Best: the effective annual rate. It puts flat and reducing-balance loans on the same footing.
• Simplest: the total you will repay over the same tenure. Two loans of RM 10,000 over 60 months are easy to rank by their totals.
• Misleading: the flat rate on its own, or the monthly instalment on its own. A small instalment over a long tenure can be the most expensive option of all.

Common questions

Is a flat rate a bad thing? No. It is a method, not a trick. Its advantage is that the total is fixed and clear. Its disadvantage is that the headline number understates the true yearly cost, which is why the effective rate must be shown next to it.

If I settle early, do I get the interest back? Under a flat rate the interest was calculated for the full tenure. At MyOneCredit you can settle at any time with no fee, but the interest is not refunded. The saving therefore comes from choosing a shorter tenure at the start, not from settling early. Other lenders have their own terms; ask before you sign, in writing.

Why does my card cost more than a personal loan? Card interest is charged on a reducing balance but compounded monthly at a much higher yearly rate, and the minimum payment barely reduces the balance. A fixed-tenure loan at a flat rate usually costs less in total. Our comparison of a licensed moneylender, a credit card and an ah long puts the numbers side by side.

See it with our own figures

Our calculator shows the flat rate and the effective annual rate together for any amount and tenure, and our rates and fees page lists every fee, itemised like a receipt.