Flat Rate, Rule of 78, Reducing Balance: How Hire-Purchase Loans Really Work

Buying a vehicle in Malaysia is set to become fairer for consumers, thanks to long-awaited amendments to the Hire-Purchase Act (HPA) that will overhaul how car loan interest is calculated.

The changes are designed to give borrowers more transparent terms and greater savings, especially for those who settle their loans early. The biggest shift is the abolition of the “Rule of 78” and flat-rate interest calculations for all future hire-purchase loans. 

These will be replaced by the reducing balance method, a simpler and more equitable formula already used in countries like Australia and the UK. How interest is calculated determines not only how much you pay, but when you pay it, and the difference between these methods is substantial.

Under the old flat-rate method, interest was calculated on the full loan amount for the entire tenure, regardless of how much you had repaid. 

For example, a typical RM100,000 auto loan over seven years at 3% interest would incur RM21,000 in total interest, making total repayments RM121,000, or about RM1,440 per month. Even if you had only a small portion left to settle, you would still be paying interest as if the full RM100,000 were outstanding. It was simple, but fundamentally unfair to borrowers.

The Rule of 78 made matters worse by front-loading interest into the earliest instalments. Using the same loan example, the first month’s interest payment would be roughly RM494, leaving RM946 to reduce the principal, while the last month’s interest would fall to around RM6, even though monthly repayments remained the same. 

This meant that if you settled the loan early, you would have paid off very little of the principal despite keeping up with your instalments, offering minimal savings and effectively penalising early repayment.

The new reducing balance method eliminates this issue. Interest is calculated each month only on the outstanding amount, not the original total. In the same RM100,000 loan, the first month’s interest would be RM250, decreasing steadily as the principal is paid down. By the final month, interest would be negligible, and settling the loan early results in real, proportional savings because you stop paying interest on what you no longer owe.

Existing borrowers may also benefit. The new rules can be applied to current hire-purchase loans if both borrower and lender agree to adopt the reducing balance method. Some lenders may begin offering this even before the Bill is formally gazetted, which is expected in the first half of 2026.

The amendments also strengthen transparency and modernise processes. Lenders must now display the Effective Interest Rate (EIR) in all marketing materials and loan agreements, giving consumers a true, comparable view of the total financing cost. 

Hire-purchase agreements can also be signed electronically, removing the need for physical paperwork and in-person signing. The new rules will come into force after an 18-month transition period to allow lenders to update their systems, though some may adopt the changes earlier. 

Source: MalayMail