Key Takeaways
- Many people overlook that the longer your loan tenure, the more interest you end up paying overall, even if the monthly instalments may seem manageable.
- When you’re choosing between different loans, compare the advertised rate (AIR) and the effective interest rate (EIR) because the latter shows the true cost of the loan after fees and compounding.
- EIR predominantly factors in administrative fees and repayment schedule.
- Before you commit to anything, always check the repayment schedule — how much you’re paying each month, payment frequency, and the total cost. A quick look now can save you a lot of stress later.
Interest rates. Two words that can either make you smile or tear up, depending on whether you’re saving or borrowing.
Either way, the first thing you’ll do is compare interest rates. You may also notice a second set of numbers – the effective interest rates (EIR). Wait, what is the difference between the EIR and the advertised annual interest rate (AIR)?
While highly attractive, the latter does not account for administrative fees, compounding interest, or your payment frequency. On the other hand, the effective interest rate provides a more comprehensive figure for the loan repayment amount you will pay.
Although there’s no clear relationship between loan tenure and the effective interest rate, the shorter your loan tenure, the lower the overall interest you’ll pay throughout the life of your loan. But that also means a higher monthly repayment amount, which you will definitely need to assess to see if it’s sustainable for the entire loan period. Before making a decision, request the bank’s detailed repayment schedule.
Interested to learn more about effective interest rates? Read on as we uncover everything you need to know about this seemingly complex, tricky loan jargon.
What is the effective interest rate (EIR)?
EIR in loans
To put it plainly, the effective interest rate (EIR) gives you a more accurate picture of what you would be paying for your loan. Financial institutions use a formula derived from the advertised rate, additional fees and your loan repayment schedule.
The EIR reflects your true cost of borrowing, which is why it is essential to look at this figure to make a more informed decision that takes your overall financial commitments into account.
In Singapore, all financial institutions, including banks and money lenders, are mandated by law to compute and disclose the EIR of their loan packages to borrowers. This is to ensure that borrowers are aware of the EIR’s compounding effect on their loan and can compare effectively before making a decision.
EIR in savings accounts
For bank savings accounts, effective interest rates are usually tiered.
These are the bonus rates you would get on top of the base rate for fulfilling specific criteria. For example, the OCBC 360 account offers a base interest of 0.05% p.a. but up to a maximum EIR of 5.45% p.a. on the first S$100,000 based on the following banking activities:
| Salary | Save | Spend | Insure | Invest | Grow | |
| First S$75,000 | 1.20% | 0.40% | 0.40% | 1.20% | 1.20% | 2.0% |
| Next S$25,000 | 2.40% | 0.80% | 2.40% | 2.40% | ||
| E.I.R.1 | 1.50% | 0.50% | 0.40% | 1.50% | 1.50% | 2.0% |
1For maximum EIR illustration purposes for your first S$100,000:
Salary + Save: You will earn a maximum EIR of 2.05% a year.
Salary + Save + Spend: You will earn a maximum EIR of 2.45% a year.
Salary + Save + Spend + Insure / Invest: You will earn a maximum EIR of 3.95% a year.
Salary + Save + Spend + Insure + Invest: You will earn a maximum EIR of 5.45% a year.
Source: OCBC
Advertised interest rate vs effective interest rate: Why EIR is more important
When comparing loans, the number you should pay close attention to is the effective interest rate (EIR).
The AIR often appears more attractive because it only shows the basic interest charged on the loan. But this number excludes key details such as processing fees, how often interest is calculated, and how frequently you make repayments.
That’s not all. Your creditworthiness matters, too. The AIR is the lowest interest rate the bank has to offer, but if your credit score doesn’t hit their mark, the interest rate provided to you will be higher than the AIR.
The EIR, on the other hand, reveals the true cost of borrowing by factoring in all of these, which is what you would realistically pay over the lifetime of the loan.
The EIR affects your loan by showing the real financial impact of your repayment schedule. If interest is calculated monthly —or even daily— your cost goes up due to compounding. Likewise, upfront fees increase the effective rate even if the advertised rate looks low.
In short, the EIR helps you compare apples to apples across different lenders and loan types. Most importantly, be sure to compare loans thoroughly before you apply.
Example 1
Using DBS’s personal loan calculator, here’s a simple table showing how a S$100,000 loan can end up costing differently:
| Loan Tenure | Advertised Rate (AIR) | Fees | EIR | Monthly Repayment | Total Repayment |
| 1 Year | 1.99% p.a. | 1% processing fee | 5.47% p.a. | S$8,499.17 | S$102,990.00 |
| 2 Years | 4.71% p.a. | S$4,332.50 | S$104,980.00 | ||
| 3 Years | 4.43% p.a. | S$2,943.61 | S$106,970.00 |
Across different loan types, the EIR will differ significantly.
With flat-rate loans — typically car loans and some personal loans — the AIR may seem low, but the EIR is usually much higher because the interest is calculated on the original principal throughout the loan.
Example 2
You decided to take a car loan from UOB for S$50,000 advertised at 2.78% p.a., which might have an EIR of 5–6% after factoring in all costs. The difference is paying more interest on a 7-year loan vs a 5-year loan vs a 3-year loan.
| Loan Tenure | Annual Interest Rate | Effective Interest Rate | Monthly Amount | Total Amount |
| 3 years | 2.78% | 5.27% | S$1,505 | S$54,170 |
| 5 years | 5.24% | S$950 | S$56,950 | |
| 7 years | 5.19% | S$712 | S$59,730 |
Example 3
In contrast, monthly rest rates, which apply to home loans, calculate interest on the remaining balance each month, so the nominal interest rate and EIR are usually the same.
Here’s an example of a S$500,000 loan paid over 20 years at a fixed rate of 2.5%. Due to home loan amortisation, the interest amount reduces with each year of repayment. Using a loan calculator, here’s the breakdown of the loan in the first 5 years.
Note that while the monthly repayment remains fixed at S$2,649.52, the interest portion reduces over time. Here’s what the repayments look like in the first 5 years.
| Year | Beginning Balance | Interest | Principal | Ending Balance |
| 1 | S$500,000 | S$1,041.67 | S$1,607.85 | S$498,392.15 |
| 2 | S$480,483.20 | S$1,001.01 | S$1,648.51 | S$478,834.70 |
| 3 | S$460,472.86 | S$959.32 | S$1,690.20 | S$458,782.66 |
| 4 | S$439,956.48 | S$916.58 | S$1,732.94 | S$438,223.55 |
| 5 | S$418,921.28 | S$872.75 | S$1,776.76 | S$417,144.52 |
How payment frequency affects EIR
How EIR is calculated on a S$10,000 loan based on 5% nominal interest over a year. Here’s how different repayment schedules affect the EIR:
| Frequency of Instalments | Instalment Amount | Effective Interest Rate |
| Once a year (1 instalment) | S$10,500 | 5% |
| Quarterly (4 instalments) | S$2,625 | 5.09% |
| Bi-monthly (6 instalments) | S$1,750 | 5.11% |
| Monthly (12 instalments) | S$875 | 5.12% |
Notice that the total repayment amount is S$10,500 regardless of the instalments. However, the more frequent the repayments, the higher the EIR. Loans with more frequent payments or fees can be more expensive, so knowing the EIR helps you compare loans fairly.
How to calculate the effective interest rate (EIR)?
To calculate the effective interest rate, use the formula below:
EIR = (1 + r/n)^n – 1
Note: “r” refers to the nominal rate (or annual interest rate) and “n” is the number of compounding periods per year. For instance, n = 12 for monthly compounding or 4 for quarterly compounding.
If you take a $10,000 personal loan with an annual interest rate of 5% to be paid over 12 months, the EIR would be calculated this way:
EIR = (1 + 0.05/12)12 -1 = 5.12%
Or you can also use an online calculator to work out the EIR.
Should you always go with the lowest EIR?
On paper, choosing the loan with the lowest EIR seems like a smart move — after all, the EIR informs you of the true cost of borrowing after factoring in account fees and compounding.
In real life, it’s not always that simple. A lower EIR is a good starting point, but it shouldn’t be the only thing you look at when deciding which loan to take.
#1 Longer tenure = Higher total interest payable
While a longer loan tenure may help to manage the load of repayment, you will also be paying more interest overall due to the higher frequency of interest compounding. In general, the longer your loan tenure, the higher the total interest paid over the life of your loan.
#2 There might be a host of extra charges
A loan with a lower EIR might lock you into a long contract with strict conditions. Some loans also charge early repayment penalties if you decide to clear your loan earlier.
If you expect your financial situation to improve — maybe you’re getting a bonus or planning to pay off your debt faster — then a loan with a slightly higher EIR that allows you to repay earlier without penalty could save you more money.
Next, look out for fees. Even though the EIR includes fees, most loan providers may still impose additional charges like late payment fees, processing fees, or annual charges.
While these may seem like one-off costs, a lender with a slightly higher EIR but fewer additional charges may offer a better experience overall.
#3 Whether you can afford the monthly repayments
Lastly, consider your cash flow. After doing the sums, you may realise that a loan with the lowest EIR may have a higher monthly instalment than others.
If these payments strain your budget, you risk missing payments — late interest charges and late fees can quickly erase any savings from the “cheaper” EIR.
It’s more prudent to stick to a range that you can repay comfortably month after month with some buffer for contingency. When in doubt, make smarter loan decisions with guidance from an experienced team of finance professionals.
Unsure about the best loans for your needs or how many loans you can take? Visit the PLF loan comparison page before making a decision.
Conclusion
While it may be tempting to take promotional rates at face value, it pays to zoom in on the details before committing to a loan. Otherwise, you may end up paying much more than you would like.
As part of their marketing efforts, banks and financial institutions usually advertise their rates with the annual interest rates. The AIR doesn’t factor in an individual’s creditworthiness, fees, payment frequency, number of instalments, instalment amounts, and compounding interest rates, which would give you a more complete picture of your loan commitment.
In summary, before taking a loan, it’s crucial to pay attention to the EIR and compare the rates — and repayment amount — before signing on the dotted line. Don’t be hooked by the headline-grabbing advertised rates and suffer the consequences of poor decision-making.
If you need help with loan matters, such as saving on interest charges, don’t hesitate to drop us a line. While you’re at it, learn more about the best money lenders in Singapore to help you move forward with confidence.
