Hire purchase and term loans: that "four per cent" is not actually four per cent

Hook

You are buying a car for the company, and the salesman tells you: "The interest is very low, only four per cent." It sounds cheap, so you sign. The true rate on that loan is closer to eight per cent. The salesman did not lie to you. He was quoting a flat rate. And what you had in your head was the reducing balance you get on a bank loan. Both are called an "interest rate", and the methods are completely different — roughly a factor of two. And this June, the rules on this changed. Most bosses do not know yet.

Two kinds of interest rate, and where they differ

Let me set out the two methods. The first: a flat rate. It is computed on "the amount you borrowed", and it does not change from start to finish. Take a hypothetical example: borrow RM100,000 over five years at a flat rate of four per cent. How is the interest computed? RM100,000 × four per cent × five years = RM20,000. RM120,000 repayable in total, over 60 instalments. Notice that RM100,000 — in year two you have already repaid part of the principal, but the interest is still computed on RM100,000. In year five you have only a little principal left, and the interest is still computed on RM100,000. The second: a reducing balance. It is computed on "the amount you still owe". Repay the principal from RM100,000 down to RM80,000 and the interest is computed from RM80,000; down to RM50,000 and it is computed from RM50,000. The more you repay, the less the interest. Hire purchase has traditionally quoted a flat rate. A bank term loan quotes a reducing balance. Put those two quotations side by side — you are not comparing the same thing.

Settling early: why it used to save you nothing

The second thing, and more people have been burned by it. "If I settle early, do I save a lot of interest?" The answer used to be: not much. Why? Because traditional hire purchase computes the rebate by a method called the Rule of 78. What that rule does is load most of the interest into the early years of the repayment term. So you borrow over five years, and after two years you want to clear it — you find you have already paid most of the five years' interest. The rebate is small, and you do not save much. Plenty of bosses find this out for the first time when they ring up to ask for the settlement figure. "I have been paying for two years, how do I still owe this much?" That is why.

This June the rules changed (the most important part of this episode)

Now the most important part, because it is new. The hire purchase legislation was amended with effect from 1 June 2026. Two big things changed. First, the Rule of 78 is abolished. Second, new hire purchase agreements are computed on the effective interest rate, on a reducing balance. What those two together mean is this: it is a change in favour of the borrower. And what about agreements already signed? For the older batch, the banks have an arrangement — there is a discount on early settlement. And there is a transition period on this — the pace at which each bank rebuilds its systems is different, so practice during the transition will differ from one to another. The precise transitional arrangements are on the episode page, because they will change, and because it depends which financier you signed with.

How to do the books (the part most people get wrong)

Now the books. This part is where most people go wrong, and the mistake is expensive. The instalment you pay each month is not an expense. Say that again: the whole instalment cannot be taken as a cost. Why? Because there are two things inside that instalment. Part of it is principal — that is repaying debt, not an expense. Part of it is interest — that is the expense. So how are the books done? On purchase: that vehicle, that machine, is recorded as an asset at its "cash price". The principal payable is recorded as a liability. On each monthly repayment: the principal part reduces the liability. Only the interest part goes to the profit and loss. If you take the whole instalment as an expense, your costs will be overstated, your profit understated, and that vehicle will never have appeared on the balance sheet at all. And then when you want a loan, want to sell the company, or want to compute capital allowances — that vehicle cannot be found. (We said in the episode on accounting schedules: behind every figure there should be a schedule. This one especially.)

How it is deducted for tax

Get the books right and the tax follows. Three lines. One, interest is deductible. It is the cost of the financing. Two, principal is not deductible. Repaying debt is not a cost. Three, that vehicle, that machine — takes capital allowances, computed on the "cash price". Not on the total you repaid. You paid RM120,000 in all for that machine, but the capital allowance looks at the machine's cash price — RM100,000. The extra RM20,000 is interest, and it goes down a different route. ⚠️ And one cap to flag: the amount of capital allowance available on a private-use motor vehicle has a ceiling — it is not that the more expensive the car, the more you deduct. The amount is on the episode page. This is the other side of the same coin as our episode on cars and petrol: buying the car goes down the capital allowance route, using the car goes down the expense-proportion route.

So which one should you use

The last question: hire purchase, or a term loan? There is no standard answer, but there is a way to judge. Hire purchase is tied to a thing — a car, a machine, equipment. The thing itself is the security. So approval is usually quicker and easier to get. A term loan hands you a sum of money — the use is freer, it is usually computed on a reducing balance, but approval looks at your whole business and takes more paperwork. But whichever route you take — work out two things first. One, once both are converted to the same method, which is genuinely cheaper. Two, what share of your monthly cash flow this instalment takes. The second matters more than the first. Borrowing is not about whether you can get it — it is about whether you can repay it.

To close

One line to close: we have made this conversion into a free tool — flat rate, Rule of 78 and reducing balance, all three computed for you, with the whole repayment schedule and what an early settlement would cost laid out. It is at free.lttcfo.ai, open and use, no sign-up. Next time before you sign, throw the numbers in and run it once. Want to know whether the ones you already have are recorded correctly? Grab a coffee first and talk about your business. For the accounting, come to LTT. I am LTT, helping SME bosses get their accounts straight. Follow us, and see you next time.