Loans can be effective financial tools to help you achieve your goals, but they must be used wisely. If you're thinking about borrowing money, consider your options carefully.
A secured loan is when you offer something as security in return for the money you borrow - such as property, your deposits or other assets. Because secured loans are backed by collateral, they often offer a lower interest rate than unsecured loans. However, banks or other lenders can claim your asset if you default on your loan repayments. Some common forms of secured loans are debt consolidation loans, home equity loans and second mortgages.
Guarantees and sureties
If the lender is unsure about your ability to repay the loan, they can ask for a surety, or guarantee. A surety is a legally binding agreement that a third-party (usually a person or a company) accepts responsibility for the loan if you cannot make your payments. This third party is known as a surety or guarantor.
If you fall behind on the payments, the lender has the right to demand that the surety either make up the missing payments or repay the loan in full. If the surety fails to meet the obligation, the lender has the right to take legal action against the surety.
With an unsecured loan, you borrow money without putting up collateral. Interest rates for unsecured loans are higher than secured loans because you are not offering any security to the lender. Your credit score will be taken into consideration when you apply for an unsecured loan, and your score may suffer if you have trouble with repayments. Examples of unsecured loans include credit cards, personal loans, tax loans and overdraft.
Fixed vs. floating interest-rate loans
A loan with an interest rate that rises and falls - or floats - with market interest rates. The interest rates for most floating-rate loans change in accordance with the prime rate.
A loan with interest that remains fixed for the loan's entire term, regardless of market interest rate fluctuations. Some people prefer this type of loan because their payments will remain the same throughout the duration.
Interest rates of loan products
Interest is usually the main cost of taking out a loan. Always make sure you understand the method of interest calculation that the lender will use before you decide to borrow.
Depending on the types of loans, there are different commonly used basis on which interest is calculated in the market, eg monthly flat rate or annual rate for personal instalment loans and daily or monthly compound rate for credit card outstanding balance.
The cost of a loan does not only include interest. There may also be other fees and charges, eg handling fees, annual fees, associated with the loans. Therefore we need to consider both the interest cost and the related fees to understand the total cost of borrowing.
In Hong Kong, authorised institutions under the supervision of the Hong Kong Monetary Authority are required to state the Annualised Percentage Rate (APR) of personal loans and credit cards, which is calculated in accordance with the method specified in the relevant guidelines issued by the industry associations*. An APR is a reference rate which includes the basic interest rate and other fees and charges of a loan product expressed as an annualised rate. Authorised institutions are required to adopt the same set of rules and assumptions to provide a consistent basis of calculation, which will facilitate borrowers to compare loan products offered by different banks.
* The Hong Kong Association of Banks and The Hong Kong Association of Restricted Licence Banks and Deposit-taking Companies
Pay close attention to the repayment terms of your loan. With most loans, you have a set period of time to repay the money, typically anywhere from 6 to 48 months. If you choose a longer repayment period, you will reduce the size of the monthly payment, but also increase the total amount of interest you have to pay. Bear in mind that the length of your repayment period can affect the interest rate of the loan.
Documents for loan application
Most banks or other lenders will ask to see the following list of documents to support your loan application. Some lenders may require additional documentation.
- Hong Kong Permanent Resident Identity Card
- Proof of income, such as your latest payroll slip, bank statement or passbook listing your name, account and salary
- Proof of residential address, such as a utility bill or bank statement
Fees and charges
Lenders are required by law to publish their fees, but you should be aware of the fine print. Be aware of common fees and charges when borrowing:
- Handling fee charged by banks or financial institutions for processing a loan
- Early repayment charge: The bank may charge an extra fee if you pay off a loan earlier than the agreed term
- Late repayment charge: If your monthly repayment is overdue, you may be charged additional fees
- Cancellation fee: If you change your mind and cancel a loan after you've signed the contract, the bank may charge a cancellation fee
There may also be third-party costs related to your loan, such as:
- Fees for professional appraisers to determine the value of collateral property
- Legal fees paid to lawyers for processing a mortgage
- Stamp duty to the government to register a mortgage
- Premiums paid to insurers for fire or other damage coverage of a property
Reward and incentives schemes
Many banks offer their customers the opportunity to earn points on their credit card purchases that can be redeemed for merchandise, coupons or discounts. However, these reward plans also tend to come with higher interest rates and fees, so consider your financial situation and needs carefully. If you use your credit card a lot - and pay off the balance every month - a rewards plan can offer worthwhile benefits. But if you carry a sizeable balance on your card every month, a reward scheme's higher interest charges may become a burden.
The Hong Kong Monetary Authority (HKMA) is responsible for the supervision of financial institutions and the way they operate their consumer loan businesses. The HKMA's Banking Conduct Department monitors authorised institutions to ensure they comply with the Code of Banking Practice.
In terms of property lending, the HKMA strictly applies the Loan To Value ratio (the mortgage amount compared to the value of the property) and also emphasises assessment of the borrower's ability to repay by capping the borrower's Debt Servicing Ratio - the borrower's monthly repayment obligations as a percentage of monthly income. You may visit the HKMA website for more information.