BNM plans to abolish flat rate rule on personal financing products to prevent penalising early repayers

• The new proposal also requires FSPs to verify the actual purpose of the financing by requesting supporting documents from the financial consumer before treating additional financing as home financing.

KUALA LUMPUR (Dec 17): Bank Negara Malaysia (BNM) is proposing the removal of the Rule of 78 method for calculating interest on personal financing, and for certain home financing products to be treated as personal financing products with a maximum 10-year tenure cap.

The "Rule of 78" calculates a loan's interest for the entire loan term based on the original principal. A borrower thus gets no interest savings even if the loan is paid off earlier than scheduled.

Under BNM’s new proposal — outlined in the central bank's personal financing exposure draft released on Dec 13 to invite public feedback — financial services providers (FSPs) will be prohibited from offering personal financing where interest is calculated using a flat rate with the Rule of 78 method.

However, FSPs may offer personal financing with either a fixed or floating rate, or where interest is charged on the remaining principal balance after deducting payments made toward the principal.

FSPs are required to inform consumers of the effective interest rate that will apply to a personal financing product, including disclosing the effective interest rate and total repayment amount, including in advertisements and promotional materials where the rate is mentioned.

Additionally, FSPs must explain how interest will be calculated, whether on a daily or monthly reducing balance basis.

For floating-rate financing, the FSP must disclose the conditions under which the interest rate may increase or decrease, the effects of such changes, and the option for customers to maintain the original installment amount upon request.

BNM noted that the abolishment of the Rule of 78 is consistent with joint efforts by the central bank, the Consumer Credit Oversight Board (CCOB) Task Force, and the Ministry of Domestic Trade and Cost of Living through amendments to the Hire Purchase Act 1967, which is scheduled for tabling in Parliament in the first half of 2025.

Treating home financing products as personal financing products

Meanwhile, BNM also proposed that FSPs treat several types of home financing products, for personal or household purposes, as personal financing products and cap the financing tenure to a maximum of 10 years.

This includes additional financing exceeding the outstanding amount of a refinanced home loan, extra financing beyond the original loan amount after the borrower has made payments, and financing secured by an unencumbered property.

“FSPs must ensure that the computation of the debt service ratio (DSR) and the contractual monthly repayment period do not exceed 10 years,” the BNM exposure draft read.

However, this does not apply to additional financing under a home financing product used solely for renovation, mortgage-reducing term assurance/takaful, legal fees, education, or business purposes.

Additionally, this does not apply when the new financing amount, combined with the outstanding balance, does not exceed the original loan amount and tenure, or when the financing is based on pre-paid amounts or extra repayments made by the customer.

The new proposal also requires FSPs to verify the actual purpose of the financing by requesting supporting documents from the financial consumer before treating additional financing as home financing.

Public feedback on tenure reduction

BNM is also seeking public feedback on reducing the maximum tenure for personal financing products to seven years, as seen in other jurisdictions such as Australia and Singapore.

Currently, under the policy document on personal financing, the central bank has restricted the tenure of a personal financing product to not exceed 10 years.

According to BNM, the country’s aggregate household debt stood at RM1.53 trillion, with 12.6% attributed to personal financing as of end-2023. Personal financing accounted for 46.26% of total bankruptcy cases in 2023.

"As of end-April 2024, 32.8% of the loan facilities enrolled in Agensi Kaunseling dan Pengurusan Kredit’s (AKPK) Debt Management Programme were also personal financing," the central bank said.

BNM is thus inviting feedback on the feasibility of reducing the tenure, the lowest threshold that should be considered, and any potential implications or challenges if the tenure is shortened. Feedback must be submitted electronically to BNM by Feb 14, 2025, through https://forms.office.com/r/HFWD3UZFEf.

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