Interest is a fee charged by banks for lending you money. Essentially, interest is like “rent on money”.
In Malaysia, housing loan interest rates are usually quoted as a percentage above or below the Base Lending Rate (BLR). For example, if the current lending rate is 6.6%, the interest rate on a “BLR – 2.1%” loan would be 4.5%.
What is Base Lending Rate?
The BLR is the rate that banks refer to internally, before they decide how much to charge for the various products or loans they offer. The rate takes into account banks’ cost of operations, and is typically similar among the major banks. The rate is heavily influenced by the Overnight Policy Rate (OPR) set by Bank Negara.
Different types of rate: Fixed versus variable rate
A housing loan with variable (or floating) rate is a type of loan where the interest rate could change at some point in the future.
In contrast, a housing loan with fixed rate will not experience any changes to its rate throughout the entire loan period.
Most housing loans in Malaysia today have variable rates (all banks that quote their housing loan rates as “BLR – XX%” are variable rate loans).
How is interest on a housing loan calculated?
Banks charge interest on the unpaid loan amount of your home loan (also known as the loan principal or outstanding loan balance). Typically, home loan rates are calculated and charged on a monthly basis.
As an example, let’s assume you borrow a RM500,000 home loan from a bank at BLR – 2.1%. Let’s further assume that the BLR is 6.6%.
In your first month:
The total amount of interest charged by the bank is:
RM500,000 x (6.6% – 2.1%) / 12 = RM1,875.
Depending on how much your monthly instalment is, your interest charges may be less in subsequent months.
Assuming your monthly repayment is RM3,000.
In your second month:
Previous month’s interest charges = RM1,875 (see above)
Amount allocated to reducing outstanding loan = RM3,000 (previous month’s repayment) – RM1,875 (first month’s interest) = RM1,125
Outstanding balance in Month 2:
RM500,000 (initial loan amount) – RM1,125 (amount used to reduce outstanding loan in month 1) = RM498,875
The total amount of interest charged by the bank in Month 2:
RM498,875 x (6.6% – 2.1%) / 12 = RM1,871.
Daily rest versus monthly rest
Depending on the loan agreement, interest may be calculated either on a “daily rest” or “monthly rest” basis. The diagram below provides an illustration of the difference between “daily rest” and “monthly rest” interest calculation.
A home loan with daily rest calculation is almost always better than one with monthly rest calculation. The obvious advantage is that you can save some interest charges if you make a large repayment towards your home loan mid-way through the month (before your loan repayment is due).