Comparison Rates: Part 2 | Whiteboard Wednesday
This week, we revisit the topic of comparison rates with three examples to highlight how very different pricing structures can result in similar comparison rates.
- Why does this happen?
- What should I look at?
- How do I know whether it is better to get a personal loan with no fees but high interest or low interest and higher fees?
Watch Walshy to find out!
Transcript and Whiteboard Example
So last week we explored the topic of comparison rates and during the week we received feedback that the way we explained perhaps wasn't as clear as it could've been and we wanted to rehash the issue and try to crack that nut this week.
The best way to do that is to give some examples of different loan terms and pricing structures.
Recap from Part 1
Just to recap from last week - comparison rate is intended to help a borrower evaluate different lenders by breaking down the different fees and charges on those loans to one rate. By having that one rate you can then compare different lenders.
So there's a standard structure that all lenders should use when calculating this comparison rate which enables you to compare between lenders, and that's governed by law.
Three examples: Loan A, Loan B and Loan C
In terms of the examples that we are looking at today, one is a low establishment fee/high interest rate combination [Loan A] another one is a high establishment fee/low interest rate combination [Loan B] and the last one is a little of both [Loan C].
You can see that the different comparison rates are quite similar. One is at 19% the other is at 20%. So what you need to do when looking at a loan and comparing comparison rates is take into account your individual circumstances.
So if you're looking to pay the loan off relatively soon after getting it, eg within 12 months (where in this example we used a 3 year term as the basis of the comparison rate), if you're looking at repaying the loan within 12 months you probably wouldn't want to incur the $900 establishment fee. You'd be better off paying interest only. Whereas if you know the term of the loan is going to run the full course, then you may be more interested in a lower interest rate. So you will see these combinations from different lenders which can lead to confusion in the mind of the borrower as to who to go with. So the intention of a comparison rate is to enable you to compare. In this case you're looking at two that are pretty similar [Loan A and B], and your individual circumstances will probably help drive the decision.
The third case [Loan C], probably a more typical loan you'll see in the market, comprises of both an establishment fee and an interest rate, and a monthly fee. It does come out at a higher comparison rate, so again what flexibility do you want for paying off your loan?
Are there other ways to compare loans?
The other alternative way to compare lenders, besides comparison rate, is just the actual weekly repayment. Again you can see in these two scenarios, very similar repayment amounts - this one is slightly higher - but still ultimately gives you a benchmark of comparison. There might be other things that these lenders don't show in either of these, like early payout fees and other unknown fees/unascertainable fees when you take the loan out which you should also look into as well.
Comparison rates are intended to help you compare loans from different lenders. Your individual circumstances may override the information you get from a comparison rate and there are other benchmarks like repayments that you should use as well.
Thanks very much, cheers.