Never trust the bank's marketing pitch

Yesterday I received a call of a telebanker from Standard Chartered Bank who was trying to persuade me to make a credit card balance transfer to the Standard Chartered account. Too bad that I am debt free so I did not accept the offer from the telebanker. The telebanker then offered me another package to make a personal loan of RM7,200 from the bank with only 4.99% charge per annum. He told me there are 3 period selections I can choose to repay the loan, i.e. 9-month, 1-year and 1.5-year.

I was quite curious about the package of RM7,200 loan with the marginal 4.99% annual interest rate charge, so I inquired the telebanker that whether I can repay the principal plus interest of RM7,559.28 (=RM7,200 * 1.0499) at the end of 1 year if I take up the 1-year loan package? But the fellow told me that I would need make installment to repay the loan for 12 months after a month I receive the loan.

When I was listening to the telebanker about the installment to repay the loan, I realised that the loan effective annual rate is more than 4.99% per annum. Let me work out some illustrations to show how the marketing trick of the bank to mislead the borrower by pitching a loan promotion with low rate but end up the borrower needs to pay more than the loan rate without realised he is paying more.

If I borrow a loan of RM7,200 with a marginal interest rate of 4.99% to be repaid within 12 months by installment, so each month I need to pay RM629.94 (=[RM7,200*(1.0499)]/12). The effective annual rate can be worked out by using the money weighted average return method (or the so called Internal Rate of Return, “IRR”). By working trial and error on the IRR in order to make the Net Present Value of the plan to be zero, I am able to get the effective rate to be 9.09%, which is 1.82 times higher than the marginal interest rate of 4.99%. So the effective annual rate for 12-month package is shown as below:-

RM629.94/[(1+IRR)] + RM629.94/[(1+IRR)^2] + …+ RM629.94/[(1+IRR)^11] + RM629.94/[(1+IRR)^12] – RM7,200 = 0

IRR = 0.7572%

Annualised IRR = 0.7572% * 12 = 9.0867%

How about the effective interest rate of the 1.5-year loan of RM7,200? Please refer the calculation shown below:-

Monthly installment = (RM7,200*[1+(0.0499)*18/12])/18 = RM429.94

RM429.94/[(1+IRR)] + RM429.94/[(1+IRR)^2] + …+ RM429.94/[(1+IRR)^17] + RM429.94/[(1+IRR)^18] – RM7,200= 0

IRR = 0.7711%

Annualised IRR = 0.7711% * 12 = 9.25%

From the computation, it is clearly showing that the longer period we take to repay the loan with installment, the higher effective interest rate we have to pay. By knowing I need to pay the loan with principal with interest by installment, I straigh away rejected the "kind" offer from the telebanker.