This article was contributed to us by SingSaver.com.sg
Banks offer a wide range of personal loan options. Unlike the past, borrowers can now get loan approval in the span of minutes. However, the variety of loans available pose another problem. Most first time borrowers will be confused by all the options, all of which have different terms, and interest rates.
In order to minimise the cost of loans, it’s important to use the one best suited to your needs:
Three Types of Loans
Besides credit cards, three common forms of small loans are credit lines, personal loans, and balance transfers. Each of these is suited to its own purpose. You will also have to compare them against other loans of the same type, in order to get the best deal. For example, if you are looking for a credit line, be sure to look up credit lines from HSBC, Citibank, DBS, and others to find the best rates.
When most people talk about personal loans, they usually refer to personal instalment loans. The main features of these loans are:
- An effective interest rate of around nine to 14 per cent per annum
- Fixed repayment plans
- Requires a separate application each time
An Effective Interest Rate of 9 or 14 Per Cent Per Annum
The interest rate on a personal instalment loan is always lower than a credit card (around 24 per cent per annum.) In most cases, the Effective Interest Rate* (EIR) of a personal loan is around nine to 14 per cent per annum. The interest rates will differ significantly between banks, depending on current promotions.
For example, at the time of writing, Citibank has a personal instalment loan with an EIR of just 8.33 per cent. However, this may not be the case next month, or the month after. For this reason, you should always compare the rates to find the cheapest.
*The Effective Interest Rate is used to determine rates that compound more than once a year. It is higher than the nominal interest rate, because each month accrues interest based on the month before it.
Fixed Repayment Plans
A personal instalment loan has a fixed amount that must be repaid each month, over a set length of time. For example, say you take a loan for $5,000 over 12 months. The annual interest rate is around nine per cent. The repayment plan may require you to pay around $437 per month exactly, over a period of 12 months. Unlike a credit line, you cannot repay a variable amount.
If you attempt to repay the entire loan ahead of time, you will be subject to a prepayment penalty. This varies between banks, but can be up to $100.
Requires a Separate Application Each Time
You must make a loan application each time you want a personal loan. This means presenting your CPF statements, showing your tax notices, etc. You may have to wait for a day or two for your loan to be approved (although some banks are faster, and can give you same day loan approval.)
Note that there is usually a processing fee involved. This is often around 1.5 per cent of the loan amount, but the cost varies between banks. As such, you should avoid making several small loan applications, as you could be incurring a processing fee each time.
When Should You Use a Personal Loan?
You should use a personal instalment loan when you know exactly how much you need, and have a clear budget plan to make repayments.
Where possible, do not take a personal instalment loan until you know the exact amount needed. You cannot increase or decrease the loan once you have received it. For example, if you borrow $1,800 for a plane ticket, but find out the later the price has dropped to $1,600, you cannot “return” the excess $200. You will have to pay interest on it, which would be a waste of money.
As the repayments are fixed, you must be sure you can afford to pay them regularly. Unlike a credit line, you cannot pay less during one month, and then try to make up for it on the next. Paying anything less than the fixed amount will incur penalties, which can range from a $60 charge to a hike in interest rates.
A personal line of credit is a form of revolving credit facility. The main features of this loan are:
- An interest rate of around 17 to 20 per cent per annum
- Annual fee
- Flexible repayment scheme
- Only a single application needed
An Interest Rate of 7 to 20 Per Cent Per Annum
The interest rate on credit lines is higher than personal loans. Due to the high interest rate, we advise that borrowers make full repayment as soon as possible.
As with personal loans, banks have promotional periods in which interest rates drop dramatically. At the time of writing, Maybank CreditAble has an annual interest rate of just nine per cent. Always compare interest rates before choosing a credit line.
Some credit lines charge an annual fee (about $150) to maintain the credit facility. This is different from personal loans; in which you only pay an initial processing fee. As such, you should close credit lines when you no longer need them. Avoid wasting money by paying annual fees on a credit line you don’t use.
Flexible Repayment Scheme
A credit line, like a credit card, has no fixed repayment scheme. You usually pay a minimum of $50, or three to five per cent of the amount owed (whichever is higher.) You can pay less on a month when cashflow is tight, or pay off everything in a single month. Unlike personal loans, there is no fixed payment amount or prepayment penalty.
We advise that borrowers always pay more than the minimum sum, if they cannot pay off the full amount. Paying only the minimum sum can lead to runaway interest rates, much like credit cards.
Only a Single Application is Needed
Once you apply for a credit line, you can borrow up to four times your monthly income (the credit limit) from it. You can borrow or repay the money as you please, by using online banking or the ATM. Unlike personal loans, you do not need to send in a loan application each time you want to borrow (so long as it is within the credit limit.)
When Should You Use a Line of Credit?
Say you are planning your wedding, and you may face unexpected costs. Rather than take out a personal loan, you could open a credit line – you will be able to borrow to deal with costs as they arise, and you will not end up borrowing more than you need. The process of getting credit is also quicker; in most cases, a credit line can give you a loan immediately or within 30 minutes. A personal loan may take several hours or even a few days to process.
However, it takes more discipline to use a line of credit than a personal loan. As you are at liberty to pay only the minimum, it can lead to excessive borrowing if you lack self-control.
3)What is a Balance Transfer?
A balance transfer is not like the two other loans on this list, as it is a tool to reduce debt. A balance transfer shifts your existing loan on one credit card, to an interest free credit card. This gives you more time to settle outstanding debts without incurring interest. The main features of a balance transfer are:
- Debt reduction
- Transfer fees
- Flexible repayments
Say you owe $5,000 on credit card A, which you cannot repay in a single month. You could make a balance transfer to credit card B, which comes with an interest-free period (e.g. 0 per cent interest for six months.)
You would then owe nothing on credit card A, and owe $5,000 on credit card B instead. The difference is, you now have up to six months to repay the $5,000, without incurring any interest. If you had left the debt on credit card A, you would have faced interest rates of up to 24 per cent per annum.
In some cases, the interest free period can be even longer. The Citibank credit card balance transfer, for example, has an interest-free period of up to one year.
Note that, after the interest-free period, the interest rate on the new credit card will also rise to around 24 per cent per annum. So always try to complete repayment before the period ends.
There is often a fee for balance transfers. This can range from $100 to $250, so always check for the cheapest option. Do not try to try to avoid a debt by repeatedly making balance transfers – the fees incurred on each transfer will accumulate. Furthermore, the Credit Bureau of Singapore (CBS) will eventually notice the string of credit requests. This will lower your credit rating, which affects your ability to take other loans in future.
As with credit lines, you need only make minimum repayments ($50, or three to five per cent of the amount owed). However, it is advisable that you rush to complete repayments before the end of the interest-free period. Otherwise it defeats the purpose of making a balance transfer.
When Should You Use a Balance Transfer?
If you have significant outstanding debt, but can repay it in full within six months (or any other interest-free period), make the transfer to save on interest rates.
This article was contributed to us by SingSaver.com.sg