What is a comparison rate?
A comparison rate is a tool to help consumers identify the true cost of a loan.
It is a rate which includes both the interest rate and fees and charges relating to a loan, reduced to a single percentage figure. For example, a bank’s advertised interest ratemay be 5.49% and its comparison rate 6.75%.
Why did the government legislate that credit providers provide comparison rates?
This is best explained by an example. A bank could have an interest rate very low at say 3% but may every year to charge $10,000 in fees and charges. When the $10,000 is taken as a percentage over the term of the loan the true interest rate is much higher and its likely that it would be cheaper for the consumer to take an interest rate of 6% and not pay the $10,000 per year.
This is why the government legislated that comparison rates need to be included – to give the consumer a clear idea of which loan is the cheapest when all the fees and charges are taken into consideration.
When must I be provided with a comparison rate?
Comparison rates only have to be provided for:
· credit which is wholly or mainly for personal, domestic or household purposes;
· fixed term credit — that is, credit that must be repaid within a specified time period. (A home loan with a term of 25 years, and a car loan with a term of 5 years are examples of fixed term credit. In contrast, credit cards, which do not have to repaid within a particular time period, are examples of continuing credit).
How is a comparison rate calculated?
Comparison rates are calculated in accordance with a standard formula, which takes into account the;
· amount of the loan;
· term of the loan;
· repayment frequency;
· interest rate; and
· fees and charges connected with the loan, except for government charges, such as stamp duty or mortgage registration fees;
— fees and charges which may or may not be charged, because they depend on some event which may or may not occur (for example, fees for early repayment or redraw fees); and
— fees and charges which are not ascertainable at the time the comparison rate is provided.
Points to remember when using comparison rates
1. A comparison rate can be a useful tool for comparing the cost of different loans, but it is important to consider all of a loan’s features and not just focus on the comparison rate.
2. A comparison rate also does not take into account some factors which may make a loan more attractive, such as fee free banking, or flexible repayment
arrangements. For example, an offset account or redraw facility could save you a lot of money in interest so a loan with a slightly higher comparison rate but with this feature may still be the better option.
As always, any questions do not hesitate to call or email us.