Understanding effective interest rates on personal loans

Understanding effective interest rates (EIR) is essential for making an informed comparison between different loans. This guide will walk you through the basics of effective interest rates, including what you can realistically expect based on your credit history.

First, what’s an effective interest rate?

Many of us hold the misconception that the interest rates we end up paying on a loan are the exact interest rates as advertised by the provider. This is often far from the truth.

Interest rates quoted by providers are usually the advertised interest rate. This calculation only includes the interest payable on the amount you’ve borrowed. In reality, you’re more likely to end up paying the effective interest rate, which further includes fees for administration and application processing. Effective interest rates are thus a more accurate gauge of how much you could end up paying on a loan.

The effective interest rate on a loan is found alongside the advertised interest rate, in accordance with regulations by the Code of Advertising Practice for Banks. If you cannot locate the effective interest rate, this could mean that it does not differ from the advertised interest rate. Always clarify with your provider as an added measure of precaution.

Why should I care about effective interest rates?

Comparing effective interest rates on different loans with the same term could help you root out the least expensive one. That’s because the interest rate alone doesn’t take into consideration how much fees impact your payments.

The most common fee associated with personal loans is a processing fee, which covers application costs. These tend to range from 1% to 6% of your loan amount and are subtracted from your funds before you receive them.

Let’s look at an example: Say you wanted to borrow S$10,000 and repay it over 5 years. You applied with two lenders and this is what they offered:

The second lender looks like a better deal when you look at the interest rate alone. But when you factor in the processing fee, it’s clear the difference is not nearly as big — even more apparent when you look at the monthly payment.

Compare effective interest rates from personal loan providers

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Name	Product	Interest Rate From	Loan Amount	Processing Fee
Apply for a Personal Loan with Lendela		3.45% EIR: 6.5%	$1,000 – $200,000	$0	Receive a customised personal loan that meets your financial needs.	Go to site View details	Compare	loading Fetching your data...
Citi Quick Cash Loan		3.45% EIR: 6.5%	$1,000 – Up to 4x your monthly salary	$0	Enjoy interest rates as low as 3.45% p.a. (EIR 6.5% p.a.) & up to 5 years loan tenure. T&Cs apply.	View details	Compare	loading Fetching your data...
HSBC Personal Instalment Loan		3.2% EIR: 6%	$1,000 – $200,000	$88	Apply online and get up to $100 cashback and up to 1% cashback on loan amount upon loan approval. Valid till 30 September 2022. T&Cs apply.	View details	Compare	loading Fetching your data...
Standard Chartered CashOne Personal Loan		3.48% EIR: 6.95%	$1,000 – Up to 4x your monthly salary, subject to a cap of $250,000	$0	Get up to $3,100 cashback and Interest Rate as low as 3.48% p.a. (EIR 6.95% p.a.). T&Cs apply. Valid till 31 December 2022.	View details	Compare	loading Fetching your data...
UOB Personal Loan		3.4% EIR: 6.36%	$1,000 – Up to 95% of your available credit limit	$0	Get up to $3,288 cashback if you choose a loan of $15,000 or more with a term between two and five years. This online offer ends on 31 December 2022.	View details	Compare	loading Fetching your data...
DBS Personal Loan		2.88% EIR: 5.79%	$500 – Up to 10x your monthly salary	1% processing fee	Apply online using promo code 'POSBPL' and get up to 2% cashback on your approved loan with an interest rate from 2.88% p.a. (EIR 5.79% p.a), plus a 1% processing fee. Valid until 30 September 2022.	View details	Compare	loading Fetching your data...
POSB Personal Loan		2.88% EIR: 5.79%	$500 – Up to 10x your monthly salary	1% processing fee	Enjoy a fast approvals service and an interest rate starting at 2.88% p.a. (EIR 5.79% p.a), plus a 1% processing fee.	View details	Compare	loading Fetching your data...

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Your loan term is an easy-to-forget factor that goes into determining your effective interest rate.

How does this work? Looking at the previous example. Say you wanted to borrow S$10,000 from the first lender with the 11% interest rate but weren’t sure how much time you wanted to take to pay it back. Compare two different loan terms:

Three things become clear when you look at this comparison: A shorter loan term can increase your effective interest rate, increase your monthly payments but lower your overall loan cost.

Higher effective interest rates for shorter-term loans aren’t necessarily more expensive — in fact, the opposite could be true. That’s why it’s more effective to compare loan effective interest rates with similar terms. The lowest effective interest rate for the same loan term is, in fact, the least expensive.

What’s a good effective interest rate on a personal loan?

Since effective interest rates are heavily dependent on your personal credit score, it’s hard to say what makes a good overall rate.

Personal loans come with effective interest rates that range from 7% to 25%, though you can sometimes find an effective interest rate as low as 6%. The lowest rates are available for people with good or excellent credit, while higher rates tend to go to those with low credit or a poor credit history. In general, most borrowers prefer loans with the lowest effective interest rate. However, do take note that this doesn’t always guarantee the lowest payments. You’ll have to consider a range of factors alongside your effective interest rate in order to determine your final payment costs. Such factors include your loan tenure and monthly income.

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Fees that effective interest rates don’t factor in

It’s tempting to think that effective interest rates cover your total loan cost, but technically there are some other fees that don’t factor in. These fees are circumstantial, so you won’t necessarily have to pay them. They include:

• Early settlement fees. Some lenders charge a fee or penalty for repaying your loan early. You could find lenders that don’t charge early settlement fees though.
• Late fees. Most lenders charge a fee for paying late — usually S$80.
• Nonsufficient funds or returned cheque fees. If you try to make a payment from an account without enough funds, many lenders charge a fee (usually the same amount as the late fee).

Bottom line

Understanding personal loan effective interest rates is essential to making a strong comparison. Comparing effective interest rates is the simplest way to tell which loan — with the same terms — is cheapest. Instead of going by the lowest advertised rates, try getting prequalified with a few lenders to see what type of EIR you can expect.

Not sure where to start? Use our comparison tools to explore your personal loan options.

Frequently asked questions

• Can I get a personal loan with a DD risk grade?

  You may. However, expect your interest rates to be on the higher end of the spectrum. Consider looking into taking steps to improve your credit score or getting a personal loan for bad credit.

• Do personal loans help my credit?

  If you make all of your payments on time you can see your credit score rise. However, you’ll damage your credit if you’re late, default or settle your loan through a debt relief company.

• Can I calculate my effective interest rate?

  Yes, you may although it could be a confusing process. The general formula to calculate your effective interest rate is: 1 + (nominal interest rate / number of compounding periods)) ^ (number of compounding periods) – 1. This could get messy because different banks offer different definitions for compounding periods and nominal interest rates. Additionally, this calculation doesn’t include extra fees like processing costs. It’s therefore advisable for you to approach your provider with queries related to your effective interest rate.

• Could my repayment schedule affect my effective interest rate?

  Yes, this is possible. A payment plan with more frequent repayments often comes with higher effective interest rates.

• How can I get a low-interest personal loan?

  You can get typically get a low interest rate on your personal loan if you have excellent credit, so taking steps to improve your credit score might be the most effective — but time-consuming — way to get a good interest rate. If you don’t have the time for that, consider looking into a secured personal loan. Check out your other low-interest options here.

• Can I get a personal loan to buy a car?

  Yes, some lenders offer personal loans that can be used to purchase a car. However, you might want to consider taking out an auto loan instead: They’re easier to qualify for, your interest rate might be lower and you might not pay as many fees.