When applying for financing, most Malaysians look at one specific number: the monthly repayment amount. If that figure fits within the monthly budget, the loan is usually signed and approved without a second thought.

However, focusing solely on the monthly commitment often hides the true cost of borrowing. Many borrowers do not realise that the method used to calculate interest, or hidden clauses like ‘Early Settlement Penalties,’ can cost them thousands of Ringgit over the loan’s lifetime. These phantom costs often keep borrowers in debt longer than necessary, making it difficult to achieve financial freedom.

Understanding the difference between interest calculation methods is the first step toward smarter financial management.

The Hidden Cost: Understanding Flat Rates

The most common trap in personal financing is the Flat Rate calculation. This method is frequently used for traditional personal loans and hire purchase (car loans).

With a Flat Rate, the interest is calculated on the full original loan amount for the entire tenure. It does not matter if you have diligently paid off half of your loan; you are still being charged interest on the money you borrowed on day one.

For example, if you borrow RM50,000, you pay interest on RM50,000 every single month for the duration of the loan, even in the final year when you might only owe RM5,000. This is often calculated using a method known as the ‘Rule of 78,’ which front-loads the interest. This means the bulk of your early payments go toward interest rather than reducing your debt, making it very expensive to settle the loan early.

The Fairer Alternative: Reducing Balance Explained

In contrast to Flat Rates, the Reducing Balance method is generally considered fairer to the consumer. This is the method typically used for mortgages (housing loans) and overdrafts.

With Reducing Balance, you only pay interest on the outstanding amount you currently owe. Every time you make a monthly repayment, a portion goes to interest, and a portion reduces the principal debt. The next month’s interest is calculated based on that new, lower balance.

This creates a snowball effect: as your debt gets smaller, the interest charged gets smaller, allowing more of your monthly payment to attack the principal.

The Simulation: Putting The Numbers To The Test

To understand the financial impact, let’s look at a simulation comparing the two methods. We will assume a borrowing amount of RM150,000 over a 5-year tenure.

In this scenario, we will give the Flat Rate a lower advertised interest rate (5%) compared to the Reducing Balance rate (6%) to see if the “cheaper” rate is actually cheaper.

Scenario A: Flat Rate Loan

• Interest Rate: 5% p.a.
• Calculation: Interest is charged on the full RM150,000 for 5 years.
• Total Interest Payable: RM37,500

Scenario B: Reducing Balance Loan

• Interest Rate: 6% p.a. (Technically higher)
• Calculation: Interest is charged only on the declining balance.
• Total Interest Payable: ~RM24,000

The Result

Even with a higher percentage rate, the Reducing Balance method saves the borrower roughly RM13,500.

This simulation highlights a critical lesson: a lower advertised rate does not always mean a cheaper loan. The calculation method dictates the true cost. Recognising this disparity, Bank Negara Malaysia (BNM) is moving to discourage Flat Rate calculations for new unsecured loans to ensure fairer treatment for consumers.

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The Strategy: How To Save Thousands

Once you understand the math, the strategy for saving money becomes clear. To take full advantage of a Reducing Balance loan, the goal should be to pay off the debt as early as possible.

Since interest is calculated daily or monthly on what you owe, every extra Ringgit you pay immediately lowers the principal. This reduces the interest charges for the following day. Over time, making consistent extra payments can shorten your loan tenure and save you a significant amount in interest costs.

However, this strategy only works if your financier offers a Reducing Balance calculation and does not charge an Early Settlement Fee. If your loan has a penalty for paying early, you lose the benefit of clearing your debt faster.

Fairer Personal And Business Loans 

For Malaysians seeking a transparent and flexible way to borrow, GXBank offers a solution designed to avoid these common traps.

GXBank provides GX FlexiCredit for individuals and GX Biz FlexiLoan for Micro SMEs. Both products are built on a commitment to fairness:

• Reducing Balance Method: Interest is calculated on your outstanding loan balances. You will not be charged for any unutilised credit limit.
• Zero Early Repayment Fees: You are free to settle your loan ahead of schedule without penalty. This allows you to save on interest costs the moment you have extra cash.

Use Cases for Financial Health

• For Individuals: You can use GX FlexiCredit to consolidate and pay off high-interest credit card debts. By moving to a lower-interest, reducing balance facility, you can clear debt faster.
• For Business Owners: GX Biz FlexiLoan serves as excellent working capital. You can draw down funds to buy stock and pay it back immediately once your goods are sold, keeping your interest costs to a minimum.

Choosing a financial product that calculates interest fairly gives you control over your financial timeline, ensuring that when you pay more, you actually owe less. Want financing that actually works in your favour? See what GXBank offers for personal financing.