Over the past few months here in Australia, there seems to have been a steady rise in car commercials pushing an ultra low interest rate, described as a Comparison Interest Rate. We have been asked a few times about this ‘Comparison Interest Rate’ and should it be trusted.
What is a Comparison Interest Rate compared against?
This is the most common question. However, the rate is not compared to a specific benchmark.
The rate is calculated using a standard formula that incorporates:
- The amount of the loan
- The fees associated with loan
- The repayment frequency
- The interest rate.
With each financial institution following a set formula it will make it easier for you, as the consumer, to make a ‘comparison’ of the loan repayments against competing financial institutions.
The introduction of the comparison rate was to try and stamp out the ‘dodgy’ practice of using different and often confusing methods of calculating interest rates and allocating hidden fees.
What type of loans should show a Comparison Interest Rate?
The loans need to be for personal use and for fixed periods of time. For example, a five year car loan and a 25 year home loan will need to be shown at a comparison interest rate.
As Credit Cards are not for a fixed period of time, they are not required to show a comparison interest rate.
Advertised Comparison Interest Rates
The comparison interest rates advertised should follow a standard criteria. Currently, for car loans this should include the fees, be a five year term and for $30,000. For home loans, it will need to include the fees, a 25 year term and at $150,000.
Can the Comparison Interest Rates be trusted?
For the most part – yes. As with any finance deal, you do need to check the fine print for any other fees and penalties that may be incurred. For example, late payment fees.
Because the advertised rate follows a fixed period of time and a fixed loan amount, the actual rate could well be different for your particular loan versus the advertised comparison interest rate. However, if you seek home loan quotes from different financial institutions for the same loan, the comparison interest rate will be a good guide to the total cost of your loan.
Are all the fees included?
Fees associated with the normal operation of the loan are included. However, as indicated earlier, fees that could be issued such as late payment fee and other penalty fees are not included.
IMPORTANT – Fees not associated directly with the loan, such as Stamp Duty fees are not included.
What else do I need to know?
You should view the comparison interest rate as a handy ‘tool’. As we know, financial institutions are out there marketing loans and will do whatever it takes to pitch their deal in the best possible light.
For example, be wary of car deals as they may bump up the price of a car but give you a low interest rate. You think you got a great interest rate deal, but you end up paying too much for the car!
Your job is to review the loan details and if you have any doubts about anything, ask questions until you are completely satisfied that you know exactly what you are getting into.
And one last point – The interest rate, no matter how it is described, is only one factor in the decision making process. Consider the quality of the institution, penalty fees and the service that your mortgage broker and/or finance dealer can provide.
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