When it comes to car loans, the stated interest rate is not the same as the real interest rate (called the Effective Interest Rate, or EIR). This is because car loans always use what’s called a flat interest rate.
With a flat interest rate, the amount of interest you pay is fixed upon the principal. For example, say the loan amount is RM84,000, and the interest rate you pay is 3.4% per annum for 7 years.
Using the “rest rate method” of calculation, the interest you pay is based on the principal (the original loan amount) of RM84,000 every month. So the interest payable works out like this:
Your interest per year would be: 3.4% of RM84,000 = RM2,856.00
Total interest paid over 7 years: RM2856.00 x 7 = RM19,992.00
Now, added to your initial loan of RM84,000, the total amount you need to repay is (RM84,000 + RM19,992.00) = RM103,992.00
Divided over a period of 84 months, that comes down to: RM103,992.00/84 = RM1,238 per month.
In this case, the effective interest rate (EIR) for this car loan is 6.27%. In the simplest words, EIR is the true rate of interest earned, factoring in compounding effect.
Generally, the EIR is higher than the flat interest rate. It is important to find out both before taking on a loan.