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If you've ever searched for a loan, you've probably come across two different rates: interest rates and comparison rates.
When comparing loans, it's essential to understand both terms, as this could help you make a well-informed decision.
In this article, we explain the difference between an interest rate and a comparison rate and how the comparison rate is calculated.
Originally written by Jemima Kelly, November 2022.
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In a nutshell, an interest rate is the amount a lender charges a customer for borrowing money. It is usually charged as a percentage of the principal loan amount (the amount you initially borrowed) on a per-annum basis (per year).
Also known as the advertised interest rate, the interest rate charged per year by your lender is determined by several factors including, but not limited to:
The combination of all these different factors is why interest rates can vary so much between all the different lenders on the market.
There are two main types of interest rates on personal loans: fixed interest rates and variable interest rates.
A fixed interest rate is where the rate remains the same throughout a set period of time (often the entirety of the personal loan). These can be useful for people who want to know exactly how much their repayments are and then budget accordingly.
On the other hand, a variable interest rate goes up or down depending on the RBA’s official cash rate and market conditions. A variable interest rate can provide more flexibility for the borrower and generally offers the option to make extra repayments without being charged a penalty fee.
Depending on the lender and product you’re applying for, you might also be able to choose between principal and interest (P&I) and interest-only (IO) repayments.
Principal and interest repayments (P&I) are generally the more common form of loan repayment and involve paying off both the loan principal (the amount you borrowed) and the interest (the cost of borrowing) over the loan term.
More commonly associated with home loans, interest-only (IO) repayments allow you to pay just the interest on your loan for a set period, which can result in lower monthly payments initially.
However, after the interest-only period ends, you are required to start paying off the loan principal, often resulting in higher ongoing and overall costs.
Simply put, a comparison rate allows you to understand the more accurate cost of taking out a loan. It is expressed as a percentage and includes the loan's interest rate as well as specific fees associated with it.
Australian lenders are legally required by ASIC to display the comparison rate alongside the advertised interest rate whenever an individual rate is displayed.
Displaying comparison rates was made mandatory in 2003 after amendments to the Consumer Credit Code were applied. ASIC introduced the mandate to stop lenders from advertising low rates while hiding hefty fees and charges; it also helps consumers easily compare loans. Alongside displaying a comparison rate, lenders are also required to provide a warning about the accuracy of the rate and a credit guide.
A comparison rate can make it easier to compare loans and services offered by lenders and help you choose the right one for your financial situation. Plus, it could save you hundreds of dollars in fees.
Lender A offers a personal loan with a fixed interest rate of 10% p.a, while Lender B provides a personal loan with a 10.25% p.a fixed interest rate. Based on just the interest rate, Lender A would be more appealing as it offers a cheaper interest rate. However, the comparison rate for Lender A’s personal loan is 10.5% p.a, while Lender B’s comparison rate is 10.35% p.a.
Ultimately, a personal loan from Lender B could cost you less than one from Lender A as Lender A charges more in fees.
A comparison rate, also known as the Average Annual Percentage Rate (AAPR), is calculated using a formula set out and regulated by the Uniform Consumer Credit Code (UCCC).
All financial institutions and mortgage providers in Australia must use this formula. The calculation itself can be pretty confusing, so we recommend finding a comparison rate calculator online.
Tools like a comparison rate calculator can be beneficial, as comparison rates are based on a hypothetical loan, and without a worked example, they could be confusing out of context.
Alongside the interest rate, a comparison rate generally takes into account the following:
Keep in mind that a comparison rate is a guide and doesn’t include all fees and charges. For example, a comparison rate may not include:
Therefore, a comparison rate is not always an exact guarantee of a loan's actual cost; instead, it is an estimate.
We’re very transparent about our costs here at Jacaranda Finance. Our fees page has interest rates, fees, associated comparison rates, and more.
Our loans are designed to be fast, fair, and, above all, affordable, with no hidden fees. See the table below for a quick guide to our charges, or visit our fees page to learn more. For detailed information about who our products are designed for, please review our Target Market Determinations.
If you’re in the market for a personal or car loan, interest (and comparison rates) are important, no doubt. But you’ll need to look beyond just the rates to find the right loan for you.
In addition to the fees on the loan (including those not covered by the comparison rate), you should also consider things like:
We’re an award-winning online lender specialising in providing fast, fair and flexible loans up to $25,000 to the everyday Australian. Our state-of-the-art proprietary loan processing technology means our customers can:
You can also check your credit score in our Better Credit app for free, updated monthly. Thanks to Comprehensive Credit Reporting (CCR), you could improve your credit score quite quickly if you pay back your loan on time, every time.