At the beginning, we should know what a loan is comped of.
What is a loan?
Generally speaking, when 2 persons agree to make a financial transaction between them, in this agreement that one person will give an said amount of money to another who promises to repay back the amount in full on a due date, then such the amount of money, the giver of that money and the recipient are namely “loan”, “lender”, and “borrower” respectively.
The terms of this transaction are usually governed by a “loan agreement”, in which it should includes the following:
- Particular of the lender and borrower
- Principal amount/Loan amount
- Loan Tenure: The due date of loan, also known as Loan Period
- Repayment plan and options: How the loan is repaid with the loan period (monthly, as a lump sum, etc)
- Drawdown Terms: The terms of how the money is transfered from the lender to borrower
- If the loan will include interest in return to lender, these should be prepared:
- Interest Rate (may expressed in annual rate, monthly rate, etc; fixed or floating; flat rate or compounding calculation)
- Amortization table (each repayment amount of money throughout the period of repayment plan)
- If the lender requires security if the loan isn’t repaid in full:
- Collateral: The substance that is owned by borrower owns will be offered to the lender in case repayment is failed
- Consigner: The 3rd party who is responsible for the repayment of borrower
- The other costs, if any, imposed on the borrower, such as:
- Late charges: Additional cost of the loan to the borrower when a repayment is missed. It can encourge repayment plan is made on schedule.
- Administrative fees: An upfront or periodic cost to cover the lender’s expense relative to administration.
- Prepayment charges: Additional cost of the loan to the borrower when part of or full repayment is made prior to its due date. It is often included in a loan with interest to recover the loss of interest income to the lender.
As you see that a simple general loan agreement can involve may types of lender’s charges which can largely affect the total cost of a loan to a borrower. To help borrowers of knowing how expensive a loan will be on different lender, so we need a numeral representation which takes every lender’s charges of a loan into account for easy comparison across loan offers and is expressed as an annualized rate. The answer is Annual Percentage Rate (APR). To understand what APR is, we need to know why simple calculation is not enough to unveil the true cost of a loan (explanation in below).
Unsecured loan and Secured loan, what are they?
We can generalize loans available to public as Secured and Unsecured Loan:
Secured loans are loans that require collateral or security to be pledged against the amount of loan. Mortgages are the well known example. Lenders has legal recourse by foreclosing on the collateral in the event that the borrower defaults on payment.
Unsecured loans, on the contrary, are given without any collateral. Lenders take borrower’s record of concurrent monthly income and previous credit into account for lending decision. Credit cards and personal loans are the common example.
|Secured Loan||Unsecured Loan|
|Length of Loan Tenure||Higher||Lower|
Unsecured loans as riskier to the lenders so generally higher rates of interest is charged. The lender also offer it for a shorter tenure, e.g. Typical personal loan is usually grant in tenure between 12 to 60 months, the loan amount is capped at a multiple of monthly income. For example, a personal loan lender may reject a loan applicant if his credit report is below satisfactory even his employment income is regular.
Secured lending is often view as less risky by the lender and borrowers are typically able to borrow a larger amount in a longer tenure and less costly interest rates. The present collateral value of the assets is usually closely linked to but less than the loan amount.
How to tell a loan is attractive to borrowers?
Lenders, especially those who do lending as a business, are always trying to manipulate those terms for maximum profits from the borrowers by hidden the true cost of borrowing.
For example, the interest rate of personal loans – the most common type of loan in the market offered by major commercial lenders to individuals – highlighted “monthly flat rate” is as low as 0.2% (on May 2015) which means the amount of interest expense is fixed at 0.2% of the principal amount and this expense is added to each of monthly repayment throughout the Loan Tenure.
Monthly flat rate = the lender charges fixed interest rate per month and thus fixed interest throughout the repayment.
Let’s continue, here is a common situation of a personal loan:
- 0.2% Flat monthly rate is quoted
- Borrower has borrowed $10,000 principal
- Thus, monthly interest expense on the borrower is $20 ($10000 x 0.2%)
- 12-month installment (the repayment schedule is 12 months) is selected
- Monthly repayment of principal is $833.33 ($10,000 divided by 12) plus interest $ 20, or a monthly repayment amount is $853.33
- Annually, the total repayment amount is $10,240.
The calculation of total expense to obtain a loan is easy when the interest rate is flat and fixed, repayment schedule is regular and repayment period is short (i.e. within 5 years).
However, the totally actual amount of cost that a borrower pays to obtain the loan is often more than lenders’ advertised rate (i.e. borrower’s annual cost is never equal to: principal X monthly flat rate X 12-month). You can give a test drive on those online loan calculator by banks in here, here, and here. If you pay attention to the remark of these quotes, all of them charge some sort of “handling fee / management fee” on the basis of “per annum (p.a.) rate” which must be added to the repayment.
Monthly interest expense = Loan principal X Monthly flat rate X (Rate of management fee (p.a.)/12 months)
What more, if comparison of the cost of loans between dynamic repayment schedule and/or repayment amount is needed, simple calculation as above is not enough.
What is Annualized Percentage Rate (APR)?
Annualized Percentage Rate (APR) is introduced to help borrowers of knowing how expensive of any loan with different terms, so we need a numeral representation which takes every lender’s charges of a loan into account and is expressed as an annualized rate for easy comparison. The definition and requirement of APR is varying among jurisdictions. By Hong Kong law (the Code of Banking Practices, Hong Kong), APR of financial products offered by Hong Kong authorized money lending institutions (e.g. banks, registered money lenders) is required to be quoted not only on the loan agreement but also in any advertising and promotional materials, its methods of calculation must be available to public access. Secondly, its calculation is based on the “Net Present Value (NPV)” of the loan.
Why Net Present Value (NPV) is taken into account of APR? If we look at the moment when the borrower (in the above example) is going to settle the last monthly repayment of a loan in 12-month repayment plan, the net money owed to the lender is one-twelfth of the principal (1/12) but the interest required to be paid is based on original principal (principal x monthly flat rate). The actually interest rate charged on final repayment is higher than the monthly flat rate.
Actually charged interest rate on the last repayment of a 12-month repayment loan = fixed monthly interest / remaining principal = (principal X monthly flat rate) / (1/12 X principal)
In fact, borrowers owed less and less amount to lender after every monthly. The said monthly flat rate of expense is true when and only the first repayment is made. Start at the second repayment, the actually charged interest rate of a month must be higher than that of the previous month, and reach the highest in the last repayment.
We are not going to go through APR definition in details, for those who are interested in, please refer to definition of NPV and meaning of Arithmetic Progression (A.P.). In practice, computer spreadsheet software such as Microsoft Excel can calculate NPV almost instantly, please refer to Microsoft Office support here.
In general, APR is the summation of actually charge interest rate in every repayment within a year and is a mathematical presentation of the true borrower’s cost to obtain a loan.
Borrowers of simple loans are mostly not to be charged at APR
When a personal loan advertisement says a loan with monthly flat rate of merely 0.38% plus 1.5% p.a. of annual management fee in a 1-year tenure can demands ARP of 11%.
Due to the complexity in APR calculation, a general equation can be used as following:
Monthly flat rate (%) x 12 (month) x 1.9 (normalized co-efficient) = APR(%)
Who are legal lenders in Hong Kong?
In Hong Kong, it’s perfectly legal for any person (whether an individual or corporate, a registered money lenders or not) to lend money to others provided that the terms of a loan complies with Money Lender Ordinance which is the major piece of legislation to regulate money lending activities and to curb loan-sharking activities:
- Lending at “true annual percentage rate of interest” exceeding 60% is a criminal offense;
- Lending at “true annual percentage rate of interest” over 48% may be presumed to be extortionate by court case.
If a person who is carrying on business as a money lender in Hong Kong must obtain a money lender’s license as private money lender. The licensing of money lenders and regulation of money-lending transactions are governed by the Money Lenders Ordinance. The enforcer is Commissioner of Police, Hong Kong Police Department.
Banks are allowed to lend money in Hong Kong but they are regulated by tighter Banking Ordinance in addition to Money Lending Ordinance.
For protection to borrower, people can log complaints against registered private money lenders, so it is advised to verify the valid license of a private lender before engagement of any loan.
Financial institutes offering lending service
In Hong Kong, so long as the money lenders are not involving illegal loan e.g. loan-sharking and extortionate loans, individuals and corporate can offer loan in return of interest. Only the lenders who do lending as a businesses requires registration in Hong Kong. Banks, and private money lenders are common lenders offering a variety of loan products at competitive pricing:
- Banks: Banks in Hong Kong are tightly regulated financial institutes under Banking Ordinance and are regulated by the Hong Kong Monetary Authority (HKMA).
- Banking Ordinance is a stringent regulatory framework on the banks to maintain banking stability. Banks tend to have more stringent policies on screening out creditworthy borrowers.
- Under the ordinance, Hong Kong adopts the three-tier banking system to authorize and categorize financial institutes to operate the various banking activities including the loan business.
- The authorized institute includes banks, restricted license banks and deposit-taking companies.
- Private money lenders: Under the Money Lenders Ordinance, private money lenders, private company limited by shares, are licensed by the Licensing Court and monitored by the Hong Kong Police Force (Licensing Office).
Unlike authorized institutions, these private money lenders tend to offer more favorable terms and rates to borrowers and less stringent measure to borrowers’ credit report.
How expats can obtain loan for business in Hong Kong?
A growing number of Hong Kong expats who are the owners plus directors of their Hong Kong LTD company (Hong Kong Private Company Limited by Shares) find it difficult to obtain loan for their businesses. Although the interest rate of Hong Kong dollar deposit in banks have reached near zero for a few years, those financial institutions seem to hold their lending policy tighter to small to medium companies which usually lacks capital and assets for expansion.
Personal Loan is the most assessable choice of loans for expats in SME
Needless to say, if the SME can provide fixed assets e.g. property in Hong Kong, they should go for secure loan. However, SME does lack the assets or it does need the capital to acquire assets. Personal loan borrowed by the business owner is properly the most accessible source of finance.
Types of Personal Loans in Hong Kong
The two popular unsecured personal loans offered by most lending institutes are Installment loans and Revolving loans.
- Installment loans: The borrowers obtain a fixed amount of loan and repay over time to the lender. The lenders ask for a fixed amount money in return (i.e interest). The borrowers are bounded to an agreement of repayment plan which required them to repay regular and fixed amount of money plus interest over an agreed schedule (i.e. loan tenure) until the loan is settled.
- Revolving loans: While installment loans which has all of the terms fixed, revolving loans add flexibility to the borrower to decide how often they need to withdraw from the loan. The lender establishes a facility for a borrower over a specific period time, and decide the maximum limit that a borrower can withdraw from (i.e. credit limit). When the facility is valid, the borrower can always borrow as many times as required using his revolving loan facility so long as the total amount borrowed is still within the credit limit. Repayment plan is always as flexible as drawdown: no fixed repayment schedule is needed because every repayment can offset the available credit. The borrower have to bear interest expense whenever drawdown takes place.
A revolving loan facility enables a flexible financing arrangement for borrowers, mostly for businesses, because of its ability for cycling fund by drawdown, repayment and re-drawdown. It is different from installment loan because a revolving loan allows borrowers to maximize their available credit at the cost of interests on the amount of drawdown.
Commons requirement to apply for Personal Loan
Although requirements vary from lenders to lenders, in general they require the borrower must be a Hong Kong Permanent Resident aged 18 or above.
Make sure all your application documentation is available. A general personal loan application in Hong Kong requires the document as follows:
- Proof of Identity: Hong Kong Identity Card
- Proof of Address: Document of your residential address (e.g. latest utilities bill, bank statements, tenancy agreement).
- Proof of Income: The latest Tax Demand Notes are the must supporting documents. For employees (employment-source income), their latest salary slips and Mandatory Provident Fund statements. For those who are not receiving regular employment-income e.g. self-employed individuals and heavy commission-based employees, their personal or company bank passbooks showing their regular income over the 6 months.
For applicant of unsecured loan, minimum monthly employment income of HK$5,000 is usually required.
Banks have the right to access applicants credit history report from Credit Reference Agency (CRA) as part of their evaluation process. A good credit history and an ability to repay the loan are important factors in the consideration of successful application. The regulation of how banks obtain personal information of public, can be referred to here.
Requirement for an expats to get a personal loan
It is often seen that an expats with stable employment and income failed to apply for personal loan. The eligibility criteria are listed as follows:
- The holders of Hong Kong Permanent Identity Card is the prerequisite of personal loans.
- Apply the loan from the banks that have prior banking relationships with you and you should have proven to be trustworthy.
- At the last gasp, you could try applying for with private money lenders at the cost of more risky replayment plan and much higher cost.
Keynotes to compare personal loan
- Compare annual fees for maintaining revolving loans facility
- Compare handling and administrative fees for installment loans
- Compare early prepayment charges as additional fee in installment loan when full the loan is settled before the agreed due date.
- Compare late payment penalties charges as additional fee in installment loan when the repayment cannot be done on schedule.
AsiaBC can help!