Finance explained: What is a comparison rate?
If you’re looking for finance or loans you have probably come across this term: comparison rate. It comes up for personal loans, car loans, mortgages and in some cases small cash loans or payday advances. It looks like an interest rate, behaves like an interest rate but it isn’t the full story.
Comparison rates vs. interest rates
If you are shopping for a good and cheap loan, you will definitely need to know the difference between a comparison rate and an interest rate.
An interest rate is simply the rate of interest that you must pay back as part of the loan, usually shown as per annum (per year). That’s basically the added price you must pay for the money you have borrowed. It’s primarily how a financier is able to keep funding more new businesses, family homes and individual major purchases and helps grow the overall economy.
A comparison rate doesn’t just show you the rate of interest that you will be paying, but the entire cost of the loan as a simple percentage. If there are extra fees and charges included in the loan the comparison rate will reflect those charges.
It’s designed to show people how much they will be paying back as a simple, neat percentage. Looking just at the interest rate doesn’t give a complete picture of what it might end up costing.
It gives borrowers the chance to see the “true cost” of a loan more clearly.
The parts of a comparison rate
A comparison rate is made up of a few different parts, which can affect the overall “number” at the end of the day. A comparison rate is made up of the amount being lent out, the term or length of the loan, when you’re expected to make repayments, the actual interest rate and the fees and charges that come with the loan.
Note that a comparison rate does not include government fees and charges or circumstantial charges such as paying your loan off early. Some loans might charge you for optional extras such as seeing statements. Since you must request those (like with car loans for example) they cannot be included in the comparison rate calculation.
How a comparison rate schedule empowers consumers
Comparison rates are designed to keep borrowers and consumers informed as possible when deciding on the best loan for them. Responsible and licenced lenders like us at Smallloans.com.au must abide by strict rules when offering credit products. Comparison rates is a rule made by the regulators to keep credit providers honest.
The Australian Securities and Investment Commission have set standard amounts and terms that lenders must give customers. This is established in their National Consumer Credit Code. This is not a guideline, it’s the law.
Though it’s good to compare other loans against each other, it doesn’t and couldn’t possibly match a loan product, term and rate that suit your unique situation.
Thinking about comparison rates
A comparison rate is better at showing you how much a loan “costs.” A “low number” interest rate looks good on paper, but you should also ask more questions.
First question is – is this an interest rate or a comparison rate? If it’s the former, you must ask for all the fees and charges, because they aren’t included in the percentage.
You should also think about what your loan can offer you such as flexible repayment options. Other loans might be better for you in different ways, such as encouraging early payment.
So when you’re out there looking for finance one of your first questions (or the first question!) to yourself should be “is this percentage an interest rate or a comparison rate?” Now you know the difference and can make a more informed decision.