Unfortunately, ‘rest’ does not refer to relaxation. It is simply defined as the time frame at which the principal amount is reduced as you repay the loan.
The mechanics of calculation between the two are highlighted below
I. Monthly Rest Interest - Interest of loan is calculated based on the outstanding balance from the previous month.
II. Daily Rest Interest - Interest of loan is calculated based on the outstanding balance from the previous day.
Let’s take a look at the basic framework of how these two modes of calculations can affect what you pay to banks.
“Ali has a home loan of RM500,000. The interest rate is set at 5% p.a. with a tenure of 20 years. Based on the amortization formula, Ali’s monthly installment adds up to around RM3,299.78. Ali proceeds to pay his first installment on the 15th of June. ”
A table calculation breakdown is done based on the scenario above to give you a better picture.
Monthly Rest Interest
|Total Interest Payable in Month 1|| = Principal Amount * Interest Rate * 1/12
= RM500, 000 * 5% * 1/12
= RM2, 083.33
Daily Rest Interest
For the daily rest calculation, we have to first calculate the interest charged from 1st June to 15th June
|Interest Charged from 1st June to 15th June|| = Principal Amount * Interest Rate * 15/360
= RM500, 000 * 5% * 15/360
= RM1, 041.67
Now let’s calculate how much is paid to principle after paying off the interest from 1st June to 15th June
|Outstanding Loan Amount after 15th June||
= Principal Amount – (Monthly Installment – Interest Charged from 1st June to 15th June)
Now, let’s calculate the remaining interest for the rest of the month
|Interest Charged from 16th June to 30th June|| = Outstanding Amount * Interest Rate * 15/360
= RM497, 741.89 * 5% * 15/360
= RM1, 036.96
To calculate the total interest paid for that month
|Total Interest Payable in Month 1|| = RM1, 041.67 + RM1, 036.96
= RM2, 078.63
Comparison of Monthly Rest Interest vs Daily Rest Interest
|Total Saving of Interest Payable in Month 1|| = Monthly Rest Interest – Daily Rest Interest
= RM2, 083.33 – RM2, 078.63
*Note; Number of days in a year used in daily rest interest calculations will vary from bank to bank. In this illustration, we use a total of 360 days in a year. In reality, banks may use a total of 365 days in a year to crunch daily rest interest calculations.
From the illustration above, Ali saves a grand total of RM4.37 when he pays his instalment on the 15th of the month. From the daily rest interest calculations above, you will see that the earlier payments are made, the more you save.
The savings of interest payable may not be significant in the short-run (just RM4.37 in this illustration). However, the effect is compounded in the long run when you factor in the larger sum of principal reduced down the line.
Are Daily Rest Interest Rates Really Better?
It’s important to note that this is not a one size fits all scenario. The daily rest interest mode of calculation could also be a double-edged sword. Take a look at the habits below.
- Clears of monthly installments in advance
- Willing and able to make extra payment towards monthly installments
If your payment habits matches the above then the daily rest interest mode of calculation is certainly beneficial.
However, if you don’t repay your installments on time, you can end up paying more due to late payment penalties. Remember, the late payment penalties go up every day based on the daily rest interest albeit at a marginal difference.
Pragmatically speaking, the daily rest interest serves as the superior choice due to its equitable calculations of interest payable.
Additionally, it is clear that your payment behavior plays a big role in how much you save/lose. There are also several other factors to look out for, such as preference of flexi or non flexi loan (http://loanstreet.com.my/learning-centre/), lock in periods and other hidden fees/charges.
If you are shopping around for a loan, do take advantage of our Home Loan Comparison tool and find the best loans in the market today.