How to Calculate Interest on a Loan: What Methods Do Singaporeans Use?

Loans

How to Calculate Interest on a Loan: What Methods Do Singaporeans Use?

September 19, 2023

Pursuing important life goals without immediate access to funds can often be eased by taking out a loan.

When it comes to taking out a loan, making an informed decision is very important. For this, you need first to know how to calculate interest on a loan. Being able to understand the complex details of interest calculation can significantly make a difference.

In this blog, we will have a look at the methods used by Singaporeans to calculate interest on loans and explore the tools and knowledge used to estimate the cost of borrowing.

Introduction To Loan Interest Calculation In Singapore

Singapore’s loan market has a very well-developed financial infrastructure. It has a range of loan products to cater to all the needs of individuals and businesses.

These loans may be provided by banks, financial institutions, or licensed moneylenders. The presence of numerous financial institutions in Singapore results in competitive interest rates in its market for loans, which can be very favourable to its borrowers.

The Monetary Authority of Singapore (MAS) plays an essential role in regulating and supervising the financial sector and loan market in Singapore.

It is primarily in charge of issuing currency, making monetary policy decisions, and ensuring financial stability in the country. MAS also regulates and overlooks all financial institutions like banks, securities firms, and other financial entities. This, in turn, influences the interest rates set in the loans market.

Importance Of Understanding How Interest Works In Singapore

The percentage of interest you have to give over the loan you have borrowed will affect most of your economic decisions. This is because interest rates are pivots around which most of your cost of living is going to revolve.

So, the decision is on you. How much are you willing to pay for the money you borrow? Is the benefit of the loan going to be worth more than the cost you will pay?

There are several aspects you need to look at before deciding on this.

If the interest rate is low, borrowers would ideally like to seize the opportunity to access credit and achieve life milestones.

However, if the interest rate is too high, this would translate as increased monthly payments for you. It would also impose limitations on your lifestyle.

Thus, it is essential first to understand that various economic activities or decisions made in the country will affect the demand for credit, which will, in turn, affect the interest rates. The rule is simple; higher demand means higher interest rates.

Some of the economic factors that would affect the demand for loans are:

  • Nation’s monetary policy
  • Global economic trends and shifts
  • Capital flows into or out of the country
  • Country’s economic health
  • Fiscal policies made by the government

Understanding these economic factors will help you anticipate interest rate changes and make more informed decisions.

Factors That Affect Interest On A Loan In Singapore

When it comes to taking out a loan in Singapore, it is important first to know what factors will be influencing the interest that you will have to pay. Those factors are as follows:

Principal Amount: The total sum you are borrowing in Singapore Dollars (SGD) will be the basis upon which your interest will be calculated. The larger the principal amount is, the more interest you will have to pay over the term of the loan.

Loan Term: In Singapore, loan terms can vary widely based on the type of loan you take and lender policies. A shorter loan term usually has higher monthly payments but lower total interest costs. On the other hand, longer terms could result in higher overall interest expenses.

Interest Rate: Singaporean banks and financial institutions usually set rates based on various factors which can change over time. When these prevailing rates are low, you will find it more feasible to take out loans.

Compounding Frequency: How often interest is added to an outstanding loan balance is known as its compounding frequency. It directly impacts the total interest you will have to pay. A more frequent compounding will lead to slightly higher interest costs. Most loans in Singapore use a monthly compounding system.

Understanding how these factors affect the overall total interest you will end up paying will help you make informed borrowing decisions.

Types Of Interest In Singapore

Types Of Interest In Singapore

It is crucial to understand the different types of interest options you get when taking out a loan in Singapore. There are two main types of interest:

Simple Interest: This type of interest is where you have to pay fixed monthly instalments, but the interest amount you will have to pay each time is calculated based on the outstanding principal amount.

So, if the loan is paid off early, you can save on all the monthly interest payments you would have had to pay. This is possible only if you have not agreed on a prepayment penalty with your lender.

Compound Interest: With compound interest payment methods, the interest is calculated not only based on the initial principal amount but also on the accumulated interest from previous periods.

In Singapore, this type of interest is most commonly used for savings accounts, investments, and mortgages. Compound interest can result in higher overall interest costs because of the compounding effect.

Now it is up to you to decide which one would be more cost-effective for you and aligns best with your financial goals.

But how do you calculate interest on a loan?

It’s simple. Based on the type of interest, you will use the principal loan amount, interest rate, and time duration to compute the interest. Keep reading to discover detailed formulas for each type.

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How To Calculate Simple Interest In Singapore

Calculating simple interest is relatively more straightforward to understand and apply.

The formula for calculating simple interest is:

Simple Interest = Principal * Interest Rate * Time

Here the Principal is in Singapore Dollars (SGD), the Interest Rate is in decimals, and the Time is in years.

So, for example, you lend a friend SGD 10,000 at an interest rate of 4% per year for a period of three years. The simple interest you will earn will be:

Simple Interest= SGD 10,0000 * 0.04 * 3 = SGD 1,200

Since simple interest does not compound, the interest will remain constant each year.

How To Calculate Compound Interest In Singapore

It is essential to understand how the compounding effect in compound interest may affect your total interest payment.

The formula for calculating compound interest is:

Compound Interest = Principal * (1 + Interest Rate / n) ^ (n * Time) – Principal

Here Principal is the principal amount in Singapore Dollars (SGD), Interest Rate is the annual interest rate charged in decimals, Time is the number of years, and “n” is the annual compounding frequency.

Imagine you invest SGD 5,000 for five years with an annual interest rate of 3.5% which is to be compounded quarterly. On this investment, your earning would be:

Compound Interest = 5,000 * (1 + 0.035 / 4) ^ (4 * 5) – 5,000 = SGD 931.40

The compounding effect will allow you to earn more in the long term.

How To Calculate Monthly Interest In Singapore

Calculating monthly interest will allow you to understand your loan and savings in Singapore better.

The monthly interest rate can be calculated using the formula:

Monthly Interest = Principal * Monthly Interest Rate

Where the Principal is the principal amount in Singapore Dollars (SGD), and the Monthly Interest Rate is calculated by dividing the annual interest rate by 12 months.

For example, you have taken a personal loan of SGD 20,000 with an annual interest rate of 6.5%. Your monthly interest will be:

Monthly Interest = 20,000 * 0.065 / 12 = SGD 108.40

How To Calculate Daily Interest In Singapore

Some financial institutions in Singapore may use daily compounding, which will impact the amount of interest you will have to pay.

The formula for calculating daily interest is:

Daily Interest = Principal * Daily Interest Rate

Where the Principal is the initial amount in Singapore Dollars (SGD), and the Daily Interest Rate can be calculated by dividing the annual interest rate by 365 days.

Suppose you deposit SGD 10,000 in a savings account with an annual interest rate of 1.5% which is to be compounded daily. Your daily interest will be:

Daily interest= 10,000 * 0.015 / 365 = SGD 0.41

Over time these daily interest amounts will add up, resulting in a much higher amount.

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So, this is it. This is all the important information you need to know about the loan market in Singapore and how to calculate interest on a loan. Remember to keep all these points in mind before choosing the most suitable loan option to achieve your future goals.