How to Use Personal Loan Comparison Rates Wisely

Understanding Personal Loan Comparison Rates

On July 1, 2003, the Uniform Credit Code put the comparison rate legislation into effect across every Australian state and territory. This was an attempt to highlight the true cost of a loan to the consumer and to force lenders to disclose any hidden fees and charges.

While the comparison rates shown make perfect sense to those people who work in the finance industry, most of us don’t really know what they represent or how they’re calculated.

If you’re not entirely sure what they mean, it can be easy to trust that the ‘true’ rate you’re seeing is a great way to compare different loans and make a decision. Unfortunately if you choose your loan based solely on the comparison rate, this could lead you to making an oversimplified decision based only on price instead of the features of the loan, or whether it really suits your needs or not.

How Comparison Rates Are Calculated

The minimum payment you make on your loan is calculated using the effective interest rate and the loan term shown on your credit contract. However, your personal loan may also have various fees and charges attached to it. These can include establishment fees and ongoing account fees.

When you add up the repayment amount, fees and charges all together, these represent the true cost of your personal loan. As each customer borrows different amounts of money over varying loan terms, it would be impossible for a lender or bank to display an accurate dollar figure in their advertisements.

Instead, those costs are added together and calculated as a percentage rate instead. This is the comparison rate you see next to the real interest rate you’re paying.

Drawbacks of Using Only Comparison Rates to Choose a Loan

While comparison rates can give you an idea of the real cost of any personal loan you choose, they don’t take into account any of the loan’s other features or costs.

For example, some lenders may charge an early repayment fee if you pay off your loan before the end of the loan term. This fee isn’t included in the comparison rate calculations.

You also won’t be taking into account any payment flexibility on your loan. In the case of a mortgage loan, a comparison rate doesn’t include using a redraw facility or an offset account linked to your loan. These things can alter the real cost of your loan dramatically.

Checking out the comparison rate can be a great way to get a realistic idea of how much your personal loan will cost you. Just be sure it isn’t the only factor you use to determine which loan will be right for you.