The cost of a personal loan depends on a variety of factors that include: annual income, loan amount (i.e. principal) and the loan duration (also called tenure). This information is meant to help lenders measure the risk that they are taking by providing a loan to an individual. Hence, it will also impact the cost of the loan. In general, the less risky a loan, the lower the interest rate, and cheaper it will be for the borrower. This article examines how each of the three variables impact the borrowing cost for personal loans.
Table of Contents
- Average Cost of Personal Loans
- Total Cost of Personal Loans & Monthly Installment
Average Interest Rates of Personal Loans in Singapore
While interest rates vary between lenders, our summary chart provides a general overview of how much personal loans can cost. For calculations, we assume that annual incomes of about S$30,000 and personal loan principals of S$10,000.
It is important to note the difference between annual flat rate and effective interest rate. Annual flat rate is simple. Banks simply charge a flat rate of around 7% on the loan principal principal for every year of the loan's duration. If you borrowed S$50,000 at 7% for 3 years, for example, then you will have to pay an interest of S$3,500 every year. Your monthly payment, then, will be divided into equal parts of S$1,681 that include S$292 of interest payment (S$3,500 divided by 12) and S$1,389 of principal (S$50,000 divided by 36 months).
On the other hand, effective interest rate is the true cost of holding a personal loan. Because you are paying your loan back over a period of time, you don't have full access to the money you borrowed for the whole time. Therefore, effective interest rate adjusts for this factor to get to the true cost of a loan. Additionally, the effective interest rate accounts for fees and promotions that affect the total cost of the loan. On average, effective interest rate for personal loans in Singapore ranges from 11% to 14%, though some of the best personal loans in Singapore offer effective interest rates around 8 - 10%.
|Tenure||Estimated Annual Flat Rate||Estimated Effective Interest Rate|
Impact of Your Annual Income
The conventional thinking is that people with higher income are more able to pay off their debt than people with lower income. Banks believe this as well, and price loans to individuals accordingly. As we mentioned in the Basic Guide to Personal Loans, most banks require a minimum annual income of S$30,000 to qualify for a personal loan, although there are some products designed for people who make as little as $20,000 per year.
Generally, personal loans with higher annual income requirements offer cheaper interest rates given the lower risk profile of the borrower. While our average personal loan interest rate table above shows annual flat rates around 6%, this rate could jump to 9% to 13% for borrowers who make less than S$30,000 (which translate to effective interest rates of approximately 18% to 26%).
Impact of the Amount You Want to Borrow: Principal
The total amount of money you want to borrow, otherwise called principal, also has an effect on the cost of your personal loan. Typically, bigger loans are only available for people with higher income, and that means that bigger principal amounts tend to come with lower interest rates. Typically, most banks will not make a personal loan below the amount of S$500 to $1,000. The maximum amount typically ranges from 4 times to 8 times your monthly income.
Impact of the Duration of Your Loan: Tenure
Finally, when considering the duration of personal loans, longer loans tend to have lower annual interest rates, but higher total costs. From a bank’s perspective, they want to make a certain amount of profit on the loans they make. If a loan’s duration is long (say 5 years), they have 5 years to collect the loan and interest from the borrower. This means that the bank will be collecting more dollars from the borrower in the form of interest payment. For instance, if you borrow $10,000 at 5% flat annual interest rate over 5 years, you have to pay an interest of S$2,500 over 5 years (10,000 x 5% x 5 years).
Because of this dynamic, banks tend to be more generous with the interest rates offered on a longer term loan. Therefore, our table for Average Cost of Personal Loans shows the interest rate declining for longer term loans.
This dynamic creates a dilemma for some borrowers. You have to think for a bit before deciding what kind of tenure you want on your personal loan. On one hand, you want to pay as little as possible in interest. On the other hand, you may want a lower monthly payment that is more easily manageable. Our recommendation is to get as short of a duration as possible while keeping monthly payment to a level that you can easily manage. This will help you find the right balance of keeping the overall cost of loan down while not straining your personal finances.
Lastly, most banks make personal loans that last 1 to 5 years. Some banks make longer loans up to 7 years.
Most banks charge a processing fee. This is supposed to cover the expense of processing loan applications and preparing the necessary materials (like your credit report) to approve your loan. It typically ranges from 1% to 2% of your principal, or sometimes a fixed amount of S$80 to S$200 is charged regardless of the loan size.
For smaller loans, it makes more sense to go with a 1% - 2% processing fee than a fixed sum of S$80 to $200. Take an example of a person taking out a personal loan of S$2,000. If they pay a 2% processing fee, that amounts to S$40, which is cheaper than even the lowest fixed processing fees. As a rule of thumb, we recommend going with 1% - 2% processing fee for principal amounts below S$4,000.
On the other hand, larger loan amounts would be more appropriate for fixed processing fees. If you take out a loan of S$20,000, a 2% fee would be S$400, twice as much as the highest fixed fees we’ve seen at S$200. Generally, it is preferable to choose the fixed fee version for bigger loans of S$4,000 or more. Just make sure to calculate what you end up paying in terms of dollar amount before choosing which loan to choose.
Early & Late Payment Penalty Fees
Understandably, banks do not like it when borrowers make late monthly payments. Late payments signal to the bank that the borrower is at risk of defaulting on the loan, which will result in a loss for the lender. To incentivize borrowers to pay on time, banks charge late payment penalties. When borrowers are late in their monthly payment, banks charge somewhere around 25% (or whatever the prevailing interest rate is at the time) on the overdue amount, and add a penalty fee of 2.5% or S$60 to $S100 on top of that. We strongly recommend you always make on-time payments to avoid these costly fees and minimize the total cost of your loan.
Another fee commonly charged by personal lenders is an early repayment (or prepayment) penalty. When borrowers pay off their debt earlier than the bank expects, the lender ends up making less interest income from the loan than they initially expected. To make up for the difference, they charge a prepayment penalty. This can range from 2.5% to 3% of redemption amount, or sometimes can come in a form of fixed fee ranging from S$100 to $250. Given this, it is crucial to carefully consider the loan duration that you require before applying and to stick to the scheduled payments.
Total Cost of Personal Loans & Monthly Installment
The total cost of your personal loan is the sum of interest payments and the processing fee you pay over the course of your loan’s tenure. As long as you don’t make late or early payments, this is the amount you end up paying to the lender in exchange for borrowing the money.
In order to calculate how much you need to pay back to the lender on a monthly basis, first multiply your annual flat rate by you principal loan amount. Then, multiply this amount by the duration of your loan in years. Then add this amount to the principal you borrowed. Dividing this by the duration of your loan in months will result in the monthly payment (also called monthly installment) that you need to make to the bank.
These two numbers are the most important factors you want to focus on before submitting an application for personal loan. You want to minimize the total cost of your personal loan, while making sure that your finances can comfortably handle the monthly installment required to pay off the loan.