This article first appeared in The Edge Malaysia Weekly on October 13, 2025 - October 19, 2025

THE distortion created by the Rule of 78 is stark.

A nominal interest rate of 3% on a nine-year hire purchase loan translates into an effective interest rate (EIR) of 5.5% (see table). At 6%, the disparity widens further, with the true cost ballooning to 10.33%.

Most borrowers are unaware of the EIR and the actual interest cost they incur on their hire purchase loans. Furthermore, under the Rule of 78, borrowers would not save on interest cost even if they opted for an early loan settlement.

Things will be different soon as the Rule of 78 is to be removed following the passing of the Hire Purchase (Amendment) Bill 2025 last week. Some see this as a watershed moment in Malaysia’s consumer finance landscape.

The legislation changes the method of how hire purchase loans are calculated, abolishing both the flat rate and the Rule of 78 — two entrenched mechanisms that have distorted loan disclosures and disadvantaged early redeemers.

An analysis by The Edge comparing monthly instalments under the reducing balance method and the Rule of 78 finds that the total interest paid over the full loan tenure remains the same (see table). 

This shows that borrowers have actually been paying an EIR of 5.5% under the Rule of 78 even though  the interest rate stated in the loan agreement  is 3%.

The repayment structure under the two methods differs markedly. The reducing balance method allocates a higher portion of each instalment to the principal repayment, especially in the early months. This benefits borrowers who settle their loans early as it lowers the total interest paid and reduces the interest income of banks. For loans held to maturity, the financial impact on both parties remains unchanged.

The bill also revises the ceiling for EIRs on fixed-rate hire purchase loans. Under the new structure, loans with tenures of up to five years will be capped at 17% per annum, while those exceeding five years will be capped at 16%. The rate for variable loans remains unchanged at 17%. These caps are intended to prevent excessive interest charges while allowing lenders to price risk appropriately.

Although frequently used in tandem, the flat rate and the Rule of 78 serve distinct functions. The flat rate calculates interest on the full principal amount across the entire loan tenure, regardless of repayments made. This method assumes a static principal throughout the loan period, resulting in interest charges that do not decline over time.

The Rule of 78, meanwhile, governs how monthly instalments are apportioned, using front-loading interest payments so that a disproportionate share of early instalments goes towards interest rather than principal. The structure has discouraged early settlement, offering little to no interest savings and effectively locking borrowers into a costlier repayment path.

Under the new framework, these practices will be replaced by the EIR and the reducing balance method. The EIR reflects the true financing cost of a hire purchase agreement.

For fixed-term contracts, it captures the full interest burden over the loan’s duration. For variable-term agreements, it is benchmarked against a reference rate, offering a more dynamic and market-aligned approach.

The reducing balance method for interest payment, meanwhile, ensures that interest is calculated on the outstanding principal, resulting in a more equitable repayment structure.

The EIR for hire purchase loans will be higher once the bill takes effect. The hike is a reflection of the actual cost of financing, which was not shown to borrowers in the past.

Notably, the higher rate stated in the loan agreement is not because the bank is charging a higher rate.  Instead, it reveals the true cost of borrowing that was previously obscured by outdated calculation methods. 

Investment analysts believe the direct financial impact will be minimal.

New Paradigm Securities head of research Ben Shane Lim notes that banks have had ample time to prepare, thanks to a relatively long transition period. The only material exposure, he adds, stems from a narrow segment of borrowers who opt to redeem their loans early under the Rule of 78. Even in those cases, early settlement fees typically imposed by banks help mitigate any potential loss in interest income.

Lim says that while the optics may appear unfavourable, suggesting that banks have profited from outdated practices, the reality is more nuanced.

Most borrowers who service their loans to maturity will be no worse off under an equivalent EIR structure.

“The real shift is in perception,” he says. “It’s not about banks losing money. It’s about borrowers finally seeing the true cost of their loans.”

Kenanga Research banking analyst Clement Chua echoes this view, noting that fixed-rate hire purchase loans comprise only about 10% of public listed banks’ loan books. Given that interest charges are front-loaded under both the Rule of 78 and the EIR, the earnings impact is expected to be modest.

“I don’t reckon it will cause significant pressure on earnings. The interest recognition profile is similar, and the affected segment is relatively small,” says Chua.

He highlights that non-bank financial institutions are unaffected as they have long adopted the EIR and the reducing balance method in their accounting practices.

According to New Paradigm’s Lim, banks have been recognising interest income based on the EIR since the adoption of the Malaysian Financial Reporting Standards (MFRS) 9 in January 2018. This means the shift is more about aligning consumer-facing disclosures with existing accounting standards than overhauling internal financial systems.

Among listed banks, those with the highest exposure to hire purchase loans include Affin Bank Bhd (KL:AFFIN) at 22.5% of total loans, Public Bank Bhd (KL:PBBANK) at 18.5%, Malayan Banking Bhd (KL:MAYBANK) at 13.1% and Hong Leong Bank Bhd (KL:HLBANK) at 11.5%. These institutions may face closer scrutiny, but analysts expect them to manage the transition without material disruption.

Having cleared its second reading in the Dewan Rakyat, the bill will come into force upon gazettement. 

Before that, it must pass through the Senate — whose earliest sitting is scheduled for December — and receive royal assent. Once signed into law by the minister, the legislation will be gazetted and formally enacted, with implementation expected in 2026.

To facilitate industry transition, a grace period of 18 months has been provided for hire purchase providers to adopt the new method. Upon enactment, providers who are operationally ready may implement the new approach immediately, while those who are not may utilise the grace period to prepare. 

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