Hire purchase rules are changing – flat rate, Rule of 78 out; EIR, reducing balance method starting next year

In September this year, Bank Negara Malaysia issued a new policy document on personal financing which outlined a series of measures aimed at promoting prudent and responsible financing practices among financial service providers (FSPs), while also ensuring consumers are better informed to encourage responsible borrowing behaviour.

Of particular interest in this document are paragraphs 10.11 to 10.13, which prohibits FSPs from using a flat rate (also known as simple interest rate) and/or Rule of 78 method to compute interest/profit charge when offering personal financing from January 1, 2027.

Later in October 8, 2025, the Dewan Rakyat passed the Hire Purchase (Amendment) Bill 2025 which also abolishes the flat rate and Rule of 78 method once the amended Hire Purchase Act is gazetted, which is expected in Q1 2026. As such, hire purchase providers are given a grace period of 18 months from the date the amended Act is gazetted to implement these measures.

It should be noted that the amended Hire Purchase Act 1967 (HPA 1967) is governed by the ministry of domestic trade and costs of living (KPDN), which works with BNM where the latter regulates banks that offer hire purchase products.

To better explain how the amendment will affect hire purchase loans moving forward, BNM recently invited us to its ‘Fostering Fairer Conduct among Financial Service Providers’ media workshop, and here are the key takeaways:

What’s it like now?

When you take a hire purchase loan, you are typically shown the flat rate which is used to calculate interest payments based on the original loan principal. For example, if you take up a nine-year loan for RM100,000 with a 3% flat rate, your total interest would be RM27,000 (RM100,000 x 3% x nine years).

Adding the total interest payable to the principal amount (RM100,000), you arrive at RM127,000, which is then divided by the number of months (nine years = 108 months) to give a monthly instalment amount of RM1,176 (rounded for easier understanding).

With each monthly instalment paid, the amount is split to pay off the interest and principal, which, in the simple interest method would be the same throughout the entire loan tenure. However, this isn’t the case as hire purchase providers do not follow this simple interest method.

Instead, hire purchase providers use a method called the Rule of 78 which apportions more of the interest earlier in the loan term before progressively reducing it towards the end. We’ve covered this topic before.

The short of it is that the Rule of 78 isn’t favourable to those who wish to settle their loan early. This is because with most of your instalment amount being directed to pay off the interest in the early period of the loan, a good portion of the principal amount still needs to be settled.

How do the amendments to the HPA 1967 help consumers?

Banks can no longer use a flat rate to market their hire purchase products once the 18 months grace period ends. Instead, they must provide the effective interest rate, which better reflects the true cost of borrowing by taking into account additional fees, charges as well as the amortisation schedule.

The formula to get the effective interest rate is complex, but running the numbers through a readily available online calculator, the EIR for the example above is 5.5%. While the flat rate of 3% seems attractive, it does not reflect the actual cost of borrowing as how EIR does.

If one hire purchase provider advertises a low flat rate of 3% but the resulting EIR is 5.5%, and another provider advertises an EIR of 5%, you’ll definitely pay less interest with the latter. In simple terms, EIR helps you to better compare various loan offers on an apple-to-apple basis – lower EIR, less interest. Hire purchase providers must disclose the EIR to customers, regardless if they opt for a fixed rate or variable rate hire purchase once the 18 months grace period ends.

To go along with the EIR, the other big change is the use of a reducing balance method to calculate interest/profit. Those with house loans will know exactly what this means but for those who don’t, the amount of interest payable will be calculated based on the outstanding principal and not following the Rule of 78.

This is advantageous for those who plan to settle their loans early, as there will no longer be anymore front-loading of interest in the early period of the loan. Here’s a direct comparison using the same 3% flat rate and 5.5% EIR examples mentioned above:

Click to enlarge

As you can see, the reducing balance method results in you paying less interest as the loan progresses compared to the Rule of 78 method, the latter having a different formula to calculate monthly interest.

It’s important to note that both methods meet at the same end point if you run the full loan tenure, which is you paying a total of RM127,000 (principal plus interest) to the bank. However, if you decide to settle the loan early, you enjoy more savings as the amount of interest payable is reduced over time. There is a “tipping point” where the savings are maxed out and start to reduce, which is around the three-year mark.

According to BNM, this switch is consistent with global practices that has abolished the Rule of 78, such as in Australia, New Zealand and United Kingdom. With EIR better reflecting the true cost of borrowing, it will be easier for you to shop for a hire purchase loan. Meanwhile, the end of the Rule of 78 and adoption of the reducing balance method means you won’t be “punished” as severely for wanting to settle your hire purchase loan early.

Anything else I should know about?

Other important things that BNM highlighted is hire purchase providers must disclose to consumers that the EIR is capped at 17% per annum for loans with tenures up to five years, and 16% per annum for loans with tenures of more than five years. Variable rate hire purchase loans have their EIR capped at 17% per annum, as per existing practice.

Additionally, the terminology has also been updated, with ‘base lending rate’ being replaced with ‘reference rate’. The reference rate refers to BNM’s standardised base rate (SBR) which follows the overnight policy rate (OPR). This is part of BNM’s revised reference rate framework that came into effect on August 1, 2022, but is now making its way to hire purchase loans.

Previously, banks will use funding costs and the statutory reserve requirement (SRR) cost imposed by BNM as the benchmark to quote their base rate. With the switch, the SBR is the same for all banks, to which they add on the spread (interest rate a bank receives on a loan) for the effective lending rate (ELR).

Lastly, consumers will have more flexibility to opt for electronic or digital signatures and to receive hire purchase agreements and related documents electronically. Put simply, the signing method isn’t limited to you being there physically, as you can also sign a document using a digital or electronic signature, kind of like how insurance agents do with their iPads.

As protective measures for consumers that opt for electronic signatures, hire purchase providers will be required to conduct verification on consumers during the initial signing of the agreement. Documents can be delivered electronically in addition to the current methods of hand delivery and via registered post.

BNM did provide a few FAQs that it received, one of them being whether consumers should hold off on buying cars until the amended Act comes into effect. The answer is no, because unless you plan to settle earlier and intend to maximise interest savings, there’s not that big of a difference.

The central bank also said that monthly instalments (as the example shows) won’t differ between systems. The goal is to create a more transparent loan shopping environment where comparing EIR is all consumers need to do instead of having to dig through the (usually) complicated product disclosure sheet, which can confuse those who aren’t financially literate.

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