Why and How Should You Compare Interest Rates
- Car Finance,
- Aug 30, 2019
Taking a loan can be quite a hassle. You would stand in lines, wait for days, and when you finally get your loan, you have to pay it back with a large interest rate. You might think, “Where did this all go wrong? I chose the package with the lowest interest rate. How is it still so high?” You might not get an answer then because you might have overlooked the “Comparison Rate” section while selecting the most suitable package for you.
Now the question changes to, “What does comparison rate mean and why is it so important?” Basically, the comparison rate is the collective output of the interest rate and all the related fees or expenses a certain loan package covers. It means that it is the result of the summation of all the “eligible” costs and expenses that come with your package; either as add-ons or as a certain fee. Therefore, the comparison rate helps you get the idea of the “true” cost of the loan you have to pay back.
Suppose you want a car loan and a bank offers you two seemingly different packages with different interest rates, different terms, and different fee & charges. Package 1 gives you $50,000 with an 8.75% interest rate and 0.1% fee while Package 2 gives you $50,000 with an 8.5% interest rate and 0.5% fee. If we compare interest rates of both packages, Package 2 is obviously the better option. But this is where the problem begins. You can not overlook the fee or charges section like they mean nothing. Collectively, it might (e.g.) add up to make 8.85% and 9% comparison rates respectively. This way, Package 1 has a lower interest rate than Package 2 since the comparison rate of the former is way lower than the latter. A point to be noted here is that when you compare interest rates, you do not compare the interest rate and comparison rate. Instead, you compare the comparison rates of both the packages to find out which is better suited for you.
You do not even need a comparison rate calculator since the formula (and it is very basic) to calculate the comparison rate is:
When was the Comparison Rate first introduced?
Banks and other lenders tended to attract customers towards the lower interest rate packages which were accompanied by high fees and charges. Although the customers thought they were taking a low interest package, the fee and charges added up to put a strain on them. Since 2003, comparison rates were introduced to prevent this kind of fraud. Now, it is mandatory for banks to present a comparison rate for each of their packages to help people learn about how much they are going to be paying back in the agreed term. So, whenever you visit a bank, make sure they are providing you with both interest rate and comparison rate so it’s easy for you to find the package best suited to your needs.
Why should you compare Interest Rates?
Although the comparison of interest rate is quite a useful technique as itself, it does not include the additional fee in the loans. That is the only drawback of comparing interest rate and it is easily solvable by comparison the comparison rate of the given packages.
Comparing these rates have several advantages like:
1- It helps you avoid any unnecessary and surprising information about your payment return.
2- It gives you a close to exact cost of how much you are going to pay is going to look like.
3- It helps you know any small costs or fees that might prove harmful in the long run.
Is comparison rate the only thing to consider?
Absolutely not! You should not decide your loan package based solely on the information from your comparison rates. There are always other factors to consider like the add-ons, the services, the redraw availability, the extra repayments, and a linked offset account (if you’re considering taking a home loan).
You also need to take a look at the term, tenure, and the amount of loan you are taking. If you take a large amount of loan and choose a longer-term, you will have to pay less money in each term but with higher (sometimes, even varying) interest rate. However, choosing a smaller term with higher amount means high money to pay in each term but with comparatively lower interest rate… ish.
You should also consider comparing interest rates. Sometimes, they may come in handy more than the comparison rates themselves but that usually occurs in rare cases, but they sure are worth a thought!
Clarification of Difference between the Interest Rate and Comparison Rate:
Interest rate is never to be confused with the comparison rate or vice versa. Although both are derived (indirectly) from each other, they do not mean the same. Interest Rate is the percentage of the total loan you are going to pay other than the actual amount of the loan itself, while Comparison Rate is the collection of both the interest rate AND the accompanying fee and charges (this also includes any ongoing fee).
How to compare interest rates or comparison rates?
The banks already provide you with the comparison rates, but in case they fail to do so, it’s pretty simple to calculate the comparison rate, actually. Consider using an online comparison rate calculator or the aforementioned formula to calculate the comparison rate.
As to how to compare interest rates or comparison rates, it’s pretty simple; look at all the possible options you have and go for the lowest ones while keeping an eye out of the additional charges that might come with them. If you feel like a low interest rate with an additional fee and a few services is better than the one with only a low comparison rate, that’s your way to go.
In the end, it is always recommended to look out for comparison rates instead of only the interest rates since the former hold more value than the latter. In any case, all options must be considered, or at least gone through once, to determine the best of them and choosing that best. However, how you select the best one, keeping in mind the different factors, is all up to you since, at the end of the day, it’s about which loan package you feel comfortable with. When you do manage to sort out the best and acquire the loan and wish to purchase a car, never forget to run a history check, VIN number check, and PPSR search and with QuickREVs, you can easily do that in a matter of a few seconds.