PETALING JAYA: The move to abolish the Rule of 78 method that calculates interest on personal financing is seen as a positive one as it aims to promote a healthier financial environment for borrowers.
Rule 78 calculates a loan’s interest for the entire loan term based on the original principal.
This also means that borrowers who pay off their loans earlier than the term stated do not get a better deal on interest savings.
Bank Muamalat Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid told StarBiz the removal of Rule 78 will allow borrowers who opt for an earlier settlement to enjoy greater savings.
“This is because the financing principal amount has been paid in greater share relative to the share of profit (interest). This could incentivise borrowers to pay off their loans early,” he said.
This week, Bank Negara proposed to abolish Rule 78 using an exposure draft while inviting feedback from the public.
Under the new proposal, Bank Negara said it will prohibit financial services providers (FSP) from using Rule 78 in personal financial products, but they may offer fixed rates or a floating rate or where interest is charged on the remaining principal balance after deducting payments made by the borrower.
It added that personal financing will only be granted when a borrower provides a verbal or written acceptance of the offer, and the FSP is satisfied that the borrower has the means to repay based on the affordability assessment.
Bank Negara also said it will become an FSP’s responsibility to inform borrowers on how interest is calculated, including whether it is on a daily or monthly reducing balance basis.
Additionally, the central bank said it invites feedback on the feasibility of reducing the existing maximum tenure of 10 years for personal financing products.
The central bank acknowledged that in countries such as Australia and Singapore, the maximum tenure is up to seven years.
Mohd Afzanizam said reducing the tenure here in Malaysia to seven years would mean households’ indebtedness is limited to seven years instead of the 10-year maximum tenure.
“So in terms of monthly repayment, it’s going to be slightly higher, and therefore, the borrowers would really need to compute its affordability whenever they want to apply for personal financing,” he said.
Wealth Vantage Advisory licensed financial planner Stephen Yong said that Rule 78 has been widely considered an unfair practice, and abolishing it is a wise decision.
Yong explained that countries like the United Kingdom had abolished it as far back as 2005, for its disproportionate burden on borrowers, particularly in the early stages of repayment.
“Abolishing it will benefit borrowers, it allows borrowers to pay off loans earlier without unfair interest penalties, reduces the total cost of borrowing, frees up cash flow and lowers financial stress,” he said.
On the FSP side, Yong said they may see a reduction in interest income from early loan settlements.
“This, however, will be offset by the opportunity to redeploy the repaid funds into new loans. This improves cash flow efficiency and reduces the negative impact on FSP’s,” he said.
Yong also opined that the maximum tenure should be reduced down to seven years as opposed to the current 10 years and align with other countries that have done the same.
“Although shorter loan tenures may increase monthly repayment amounts, this ultimately reduces the total cost of borrowing and ensures borrowers do not overstretch their repayment capabilities, promoting healthier financial habits,” he said.
According to the proposal, personal financing had been identified as one of the top contributors of bankruptcy, accounting for 46.26% of total bankruptcy cases last year.
Yong said abolishing Rule 78 will help reduce bankruptcy rates in the country, because the current system which front-loads interest payments, traps borrowers in long-tenure loans where significant interest is paid upfront while the principal remains largely unpaid.
“This can lead to a debt snowball effect when borrowers take on additional loans to cope with financial pressures. By shifting to a fairer repayment structure, borrowers would find it easier to manage debt, especially during financial setbacks such as job loss or income reduction,” he said.
Meanwhile, The Association of Banks in Malaysia (ABM) said they will continue working with member banks as well as with Bank Negara to effectively implement any changes based on the final policy document on personal financing to be issued in the future, while addressing any operational details along the way.
“ABM and our member banks remain committed to supporting fairness, transparency and the well-being of consumers. That being said, we note that the Exposure Draft on Personal Financing which sets out the proposal to abolish the flat rate with Rule of 78 method for personal financing was just recently issued on Dec 13, 2024 and is open for feedback from the public, including banks until Feb 14, 2025,” it said.
It also noted the current maximum tenure, currently Malaysia’s 10-year tenure provides flexibility for borrowers, particularly in managing affordable monthly repayments.
“Reducing the tenure to align with other countries, such as Australia and Singapore, would require careful evaluation to ensure accessibility is not compromised for lower-income segments,” ABM said.
As for reducing the bankruptcy rates in Malaysia and its connection to Rule 78, ABM said the abolishment of it may help alleviate some financial burdens for borrowers, addressing bankruptcy requires a holistic approach.
“This includes promoting financial literacy, encouraging responsible borrowing and supporting accessible debt management solutions.”
