What is a comparison rate and how does it affect my personal loan?

Walshy’s Whiteboard Wednesday

What is a comparison rate and why is it displayed on the Fair Go Finance website? Walshy explains what a comparison rate is, how it is used and what it is intended for.

Transcript

Hi I’m Paul Walshe, founder and CEO of Fair Go Finance. So today we’re going to try and unpack the complicated topic of comparison rates. So we will try to look at why do they exist, what is it supposed to do and how do you use it?

Regulation requires comparison rates to be visible for all personal loans

So regulatory requirements have mandated that you need for a lender to show a borrower the comparison rate.

Now a comparison rate is designed to help you compare one lender to another. So it’s mostly relevant when we’re advertising personal loans on websites, on brochures, TV ads, wherever you see an interest rate and payment amount you should see a comparison rate to go along with that.

Comparison Rates: Intended to help you compare lenders

In providing you with a comparison rate is to help you compare different lenders, so across Australia you can get thousands of different loan amounts, thousands of different loan terms but the idea of the benchmark is to bring it back to six different loan amounts each having a specific loan term.

So by having the ability to compare across the six basic products it’s intended to give you a guide to a cost of their credit.

Some lenders have high interest rates and low charges, others have low interest rates but high charges – so monthly fees, establishment fees might be great but the interest rate might be advertised as zero so to avoid that misleading information on a website, or a TV commercial, the comparison rate is designed to help you compare the information from one lender to another.

How comparison rates may not indicate the cost you pay

So in terms of the comparison rate itself, there’s six different loan amounts, each with a corresponding term that is designed to help you compare between different lenders.

So for example, and just to give you an idea of how it’s calculated, if you were looking at borrowing $2,500 over two years then one lender may charge you 15%pa with no fees then the comparison rate on that is going to be 15%.

Now if that lender starts to add fees, monthly fees, establishment fees and other known fees you’re going to pay when taking out the loan, that comparison rate will go up.

So instead of them just advertising a 15% interest rate, that additional cost will be disclosed via the comparison rate on the website once all those fees are included.

So, like I said, there’s thousands of different loan amounts on the market in Australia and what you’re looking to borrow may not be one of the six loan amount terms that are in the comparison rate structure.

So really they don’t necessarily help understand the cost of credit but it should help you understand the cost between lenders.

What you’re ultimately going to pay will be more known, will be easier for you to understand, by closer investigation of information on a lenders’ website through pricing sliders or other tools or pricing guides on their websites – and that’s where you’ll need to look to get a better understanding of that cost that you’re paying.

Hopefully you found this useful, hopefully it’s helped you understand a bit more about personal loans and for more information like this follow us on Twitter or subscribe to our Youtube channel. Thanks very much.