Effective Interest Rate EIR | Guide on Effective Interest Rate
Loansby Priyadarshini 7 October 2022
Everyone understands what an interest rate is: it is a percentage of a sum over a year. If your savings account earns 0.05% interest per year you will earn $5 in interest for every $10,000 saved. However, when it comes to bank loans, you will frequently see TWO interest rates: the advertised interest rate and what is known as the effective interest rate, or EIR. In this blog, we give you a guide on Effective Interest Rate (EIR).
Effective Interest Rate (EIR)
The effective interest rate, or EIR, is intended to reflect the true cost of taking out a loan in Singapore. This is due to the fact that the loan interest rate is not the only cost. Other costs, such as the administration fee charged by a bank, are frequently included. Most importantly, it considers how long the loan tenure is and how frequently you repay the loan. This is because the effective interest rate takes compounding into account. The formula will be provided later in the article.
Currently, all Singapore financial institutions are required by law to publish the EIR of their loans. That is why you will frequently see both the Effective Interest Rate and the Advertised Interest Rate. Insisting on EIR means that financial institutions that lend you money, such as banks or licensed moneylenders, can’t use low-interest rates to hide fees or offer you unreasonable repayment terms.
Why is EIR higher than the advertised rate of interest?
Typical interest rates only consider the amount of interest charged. If you take out a $4,000 loan at 5% interest, you should expect to pay $200 in interest each year. However, EIR takes into account all other factors. For example, if there is an administrative or processing fee, you may end up paying more than that. Assume you pay a 1% administrative fee on a $4,000 loan. That’s $40. This means you must now repay $200 in interest plus $40 in fees, for a total of $240. Essentially, you’re repaying 6% of your principal.
And that is only one factor in the equation. EIR also considers how the loan will be repaid. It considers the following factors:
- Total number of installments
- Instalment frequency
- Whether or not the installment amounts are equal.
- The repayment schedule is the sum of all of these factors
Are there any online EIR calculators available?
If you want to do your own EIR calculations, the Ministry of Law provides a simple Excel-based EIR calculator. All you have to do is enter the:
- The loan amount
- Installment frequency
- Total number of installments
- Each installment’s amount
- If necessary, you can enter unequal installment amounts, though you can only enter up to 12 installment amounts
Should you always choose the lowest Effective Interest Rate (EIR)?
In general, it is wise to choose the lowest EIR. The entire purpose of EIR is to ensure that you get the lowest interest rate possible on your loan, regardless of what the bank advertises. However, there are two things to keep an eye out for:
The total amount of interest you will pay
A longer loan tenure frequently results in a lower EIR because you repay a lower amount each month. When you look at the big picture, however, a longer loan tenure means paying more interest overall.
If you can afford the monthly payments
Banks may occasionally offer you a loan with a lower EIR if you borrow for a shorter period of time. However, shorter terms imply higher monthly payments. If you have a cash flow problem, this is not a good idea. Remember that if you are unable to repay a loan in full and on time, you will be charged fees and interest on the outstanding balances. It’s pointless to be enticed by a lower effective interest rate if you’ll end up paying more than you expected.