The High Cost of Consumer Credit

The Edge, 30 October, 2006

Imagine paying at least 30% more when purchasing a piece of furniture or an electrical appliance through credit. In Malaysia, many individuals and businesses buy furniture and electrical appliances under the credit scheme because of the supposedly low weekly or monthly instalments. But what they may not realise is that the actual annual percentage rate (APR) charged in such credit purchases generally exceeds 30% per annum. In fact, in most cases, it exceeds 40%. For items like computers, cameras and camcorders, the APR could hit as high as 60% per annum.

For example, a digital video camera was advertised recently for RM1,199 cash or, if paid on a weekly-instalment basis, for RM19.15 a week for a period of two years — that’s 104 weeks, making the total payment RM1,991.60. If the customer prefers to pay on a monthly basis, this amount is divisible by 24, which comes to RM82.98.

The High Cost of Consumer Credit

If the customer chooses the monthly payment plan, his first payment is RM82.98, with 23 subsequent payments of the same amount. However, what the customer is actually doing is borrowing RM1,116.02 (that is, the difference between the cash price of RM1,199 and the first payment of RM82.98) and thereafter settles the whole sum in 23 instalments of RM82.98 each month.

Using a finance calculator that uses an iterative trial-and-error algorithm and keying in 1,116.02 for the present value, PV; 82.98 for the payments, PMT; 23 for the number of instalments, n, and solving for the interest rate, i, gives the answer 5.03% as the monthly rate. This is equivalent to an annual percentage rate of 60.36% (5.03×12)!

An APR of 60% for furniture and electrical appliances can be considered exorbitantly high, more so for the lower and middle-income groups who are the main buyers of such items on credit.

The dealers, on their part, might say the high interest charge is due to the high probability of default among these groups. Nonetheless, many customers do opt for salary deductions which, of course, minimise the probability of default.

Another reason for the high interest charge might be attributed to the fact that unlike, for example, motor vehicles and homes, there is a lack of a well-established secondary market for furniture and electrical appliances to rely upon in the event of repossession.

While consumer items can be financed through hire purchase, it is not clear if businesses of furniture and electrical appliances in Malaysia are covered under the Hire Purchase Act. If they are covered, surely the Act would not permit such high APR charges. Indeed, the Act stipulates a maximum term charge of only 10% per annum for fixed rate and 17% for variable rate.

A comparison with Singapore shows that the monthly rate never exceeds 2%, that is, an APR of not more than 24%. On a recent visit to Indonesia, this writer noticed the APR there appeared to be more than 100% for similar transactions.

Vehicle hire-purchase financing has some similarities. Unlike, for example, home mortgages where banks quote the APR itself, for vehicle loans, finance companies quote term charges that use simple interest calculations. Term charges have correspondingly much higher APRs. Take a vehicle loan of RM80,000, a quoted term charge of 5% per annum, for a duration of seven years. Under hire purchase, the monthly payment is computed as follows: The total interest payable is RM28,000 (80,000×0.05×7). The total principal plus interest payable is RM108,000. The monthly instalment is, therefore, RM108,000/84 = RM1,285.71. Computing for the monthly rate using a finance calculator gives 0.7471% [PV=-80,000; PMT=1285.71; n=84 and solve for i, the interest rate] that equals an APR of 8.965%.

Therefore, note that even though the term charge is only 5%, the actual APR is 8.965%. This increase is due to the fact that under simple interest computation the monthly interest is computed not based on the diminishing loan balance but rather on the original principal amount itself. The table provides the actual APR for different term charges and durations.

Notice that for a given term charge, the actual APR is almost double but progressively lessens the longer the duration. Therefore, it is indeed cheaper to finance cars and other vehicles in longer durations. The APR is really the “true” rate and the Hire Purchase Act correctly requires the mention of it in the hire-purchase agreement.

Perhaps the Ministry of Domestic Trade and Consumer Affairs, under whose jurisdiction the Hire Purchase Act falls, should look into the issue of consumer goods businesses imposing high finance charges on credit sales so that the poorer sections of the country are not subjected to undue burden. Finance companies should also be required to just quote the APR itself, which is the true rate, and not the term charge, which is misleading. This would also make the hire purchase rates comparable to the mortgage rates.

Since the issue is a matter of money and finance, Bank Negara Malaysia should have some say in it, particularly on the interest rate charged. Unfortunately, the banking laws protect the depositors more than the borrowers and consumers. In such a situation, consumer associations, for instance, can help tackle this imbalance by raising this issue and educating the public on its implications.

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