How Does A Home Loan Really Work?
Banks often display their home loan interest rates prominently, but they seldom explain how it works. While a housing loan is not the easiest thing in the world to understand, it isn’t rocket science either. Below, we attempt to explain the inner workings of property financing, but first, you need to understand a few key terms:
Principal of a property loan
The principal of a mortgage loan is basically the amount borrowed and not yet repaid. For housing loans, interests are usually charged on this principal amount.
Interest rates for these loans in Malaysia are usually quoted as a percentage below the Base Lending Rate (BLR). For example, if the current BLR is 6.6%, the interest rate on a BLR – 2.5% loan would be 4.1%.
The loan tenure is simply the agreed length of the loan. In Malaysia, homebuyers take out housing loans with tenure of up to 35 years.
Let’s assume you’re about to take out a mortgage of RM200,000 for 30 years, at an agreed interest rate of BLR – 2.4%. Let’s further assume that the BLR is 6.6% (which basically means the interest rate on your loan is 4.2%).
Loan Amount: RM200,000
Interest Rate: 4.2% per year
Loan Period: 30 years
The interest on all home loans in Malaysia is calculated monthly. In this case, the 4.2% yearly interest rate is equivalent to a monthly interest rate of 0.35% i.e. 4.2% divided by 12.
When it comes to making your first month’s loan repayment, applying the monthly rate of 0.35% to the principal loan amount of RM200,000 gives you an interest charge of RM700 for the first month.
Monthly repayment calculation
While your interest charge is RM700 in the first month, the banks normally require that you repay a little more than RM700 each month. This extra payment goes into bringing down the loan principal (what you owe on your housing loan).
Because your loan interest is calculated based on what you owe, by paying that little bit extra in your first month, the interest on your loan for the second month will be slightly lower.
In this example, the interest payment for month 2 is RM699 (i.e. RM199,722 x 0.35%).
In calculating the monthly amount you’re required to pay, banks use a special formula called an “amortisation formula”. This monthly amount works in such a way that by the time you get to your last payment (based on your agreed loan term), you would completely pay off your loan plus all interest due.
The monthly repayment amount is usually the same for the entire term of your loan, unless there is a change in the Base Lending Rate (which the loan interest rate is based on).