Unfair Practice Rule of 78 for early settlement of loans

I write to highlight something very important to consumers especially Hire Purchase borrowers.

I recently underwent an unpleasant experience when I looked into early settlement from Maybank.

The good side of it was that I managed to gain knowledge on how perhaps we have been duped by the financial industry without our knowledge.

This new ‘wisdom’ that I gained was what is called the insidious Rule of 78.

Several years ago, it was highlighted in a local newspaper by a consumer that the Rule 0f 78 practiced by the banking industry for small loans is recognised as unfair practice around the world.

However, I was surprised that something as important as this to borrowers and consumers is allowed to die off without action by the authorities.

This matter impacted me pertaining to a Hire Purchase transaction which I had entered into in 2013. I had bought a car, model Proton Preve 1.6CVT June 2013, as a gift for my sister.

Being an existing customer of Maybank, I was persuaded to take a hire purchase loan with Maybank Islamic, which I had agreed to for convenience.

Considering this was a gift, I chose the longest period of hire purchase (9 years) with clear emphasis that I may want to settle early and would expect a ‘rebate’ of the annual interest rate for early settlement. The bank officer assured me this was standard practise.

The amount of loan that I took was RM56,500 and based on a 2.86 percent interest rate per annum, I would be paying an amount of RM1,615.90 interest per annum.

This multiplied by 9 years meant I would be paying an interest of RM14,543.10 in total, over a 9-year period. This total interest amount added to the loan amount would mean I ‘owed’ the bank a total amount of RM71,043.10.

This full loan amount was then divided over a period of 108 months (9 years) which meant I had to pay RM658 per month over 107 months plus RM637.10 for the final month.

As I had mentioned, I planned to settle the loan earlier than 9 years and as such I had been paying an amount of RM700 per month instead of RM658 as per the contract.

As such, after making payments without fail, as at the end of June 2020 (which was more than 2 years before the end of the hire purchase term), the amount outstanding for my loan stood at RM5,000.

Towards the final quarter of 2019, I had requested for a settlement amount in order for me to pay off whatever amount outstanding, but the bank was not responsive. I in fact requested assistance from my personal banker at Maybank itself and still we did not get any response.

When the Movement Control Order (MCO) was imposed in March, we did not follow through on this request.

However, as soon as the MCO ended in June, we followed through on this request and on 29th June 2020, I received the “Confirmation of HP / IP Settlement” from Maybank Islamic’s Auto Finance Centre.

To my disbelief, the ‘rebate’ given for settling the loan 2 years in advance was merely RM681.94.

This amount was in fact way below even a one-year interest rate imposed on me (2.86% x RM56,500 = RM1,615.90).

I sought explanation form Maybank Islamic and was told that the calculation for the rebate was not ‘straight-forward’ as per the calculation for the interest – based on RULE of 78.

It seems that this rule allows banks to allocate pre-calculated interest charges that favour banks over borrowers for short-term loans or if a loan is paid off early.

The Rule of 78 methodology gives added weight to months in the earlier cycle of a loan, so a greater portion of interest is paid earlier.

Some may say that this is a commercial transaction and if a borrower agrees to take on the loan, the borrower then is presumed to agree to usage of RULE 78.

I totally disagree in this regard, as I should have the right to be informed of this unfair rule and practice by the bank and should be given the right to decide.

This was never communicated to me and like any reasonable consumer, I had rightfully concluded that any rebate given for early settlement would be based on the flat rate of interest per annum, in this case being at 2.86 percent, equivalent to RM1,615.90 per annum.

Having been made aware of this formula which I believe many are unaware of and would have been ‘deceived’ over the years, I am shocked to discover that countries like the United Kingdom and various States in USA, have outlawed usage of this Rule on consumers.

Why is Malaysia allowing this Rule to be practised by our banks? Why are banks not clearly highlighting to consumers about this Rule before the execution of the Hire Purchase?

I fully understand the need for lenders, in this case being huge profit-making financial organisations to make money.

For these lenders their profit comes from the annual interest rates. In the case of HP contracts, borrowers are informed that they are charged flat interest rates per annum for the duration of the loan.

In the case of early settlers the rebate should be calculated using the same formula.

Whatever the method the banks use, it is the responsibility of the bank to explain clearly to the consumer from the onset.

Nevertheless, I strongly believe that Rule of 78 is oppressive on borrowers and should at least be restricted in its usage. The UK, the US and other developed economies recognise this. Why not Malaysia?

Over to you, Kementerian Perdagangan Dalam Negeri dan Hal Ehwal Pengguna!

Said Din,

Kelana Jaya, Selangor

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* The views and opinions expressed in this article are those of the author and do not necessarily reflect the position of Astro AWANI.