Interest rates, APRs & comparison rates: What you need to know

Everything that has to do with finance, it also includes interest rates, APRs and comparison rates.

You get exposed to all these terms when you take a loan, purchase on credit, taking a credit card or investing money.

These are financial terms that act as an engine of finance. Getting into financial negotiations without fully understanding those words, you will probably make a poor financial decision that can also affect your credit score.

Interest rates in Australia

In Australia, the interest rate decisions are made by the Reserve Bank of Australia's Board. The cash rate is the official interest rate. The cash rate is the rate charged on overnight loans between financial intermediaries, and in the money, the market is known as a result of the interaction of demand for and supply of overnight funds. Australia’s interest rate averaged 4.28% from 1990 until 2020. Reaching a high record of 17.50% in January of 1990 and a record low of 0.50 percent in March of 2020.

Are the interest rates decreasing in Australia?

In 2019, Australia's cash target rate has dropped by 0.75%. Interest rates become lower due to short-term and long-term factors. In Australia, one of the shorter-term domestic factors is weak consumption growth which is caused by very weak wages growth.

Types of interest rates you can find in Australia

There are a lot of interest rates types that can apply to your situation. We have outlined the types and their advantages and disadvantages.

The variable interest rates

The variable rate is the most common interest rate in Australia. In the variable rate, the initial and ongoing rate is set by the lender. The lender is also allowed to change the interest rate during the loan's life. However, several lenders will only change variable rates for existing loans in response to movements in the official cash rates, as announced by the Reserve Bank of Australia.

• The advantages of variable rates; variable rate loans have no restrictions or penalties for making additional repayments on your loan, which allows you to pay off your loan sooner. With variable rates, you also benefit because if interest rates fall, your monthly minimum repayment will fall.
• The disadvantages of variable rates; when you have variable rates you are at risk because if rates rise, your repayments will increase.

The fixed rates in Australia

Most Australian lenders offer fixed rates, generally for 1 to 5-year terms. Eventually, the loan interest rate usually converts to a variable. A fixed-rate means that your interest rate remains the same during the entire fixed-rate term, even if variable market rates change. Sometimes the fixed-rate given by lenders can be either higher or lower than the variable rate at any given time, thus you need to make a comparison when considering this option.

• Advantages of fixed rate; with fixed rates you are not affected if variable rates increase because your fixed rate will not change. Fixed-rate interest is cheaper compared to variable rate interest.
• Disadvantages of fixed rate; fixed rate will remain the same and you will not receive any benefits if variable rates decrease. Your fixed rate could be higher than the current variable rate if market variable rates fall over time. Meaning a fixed-rate loan could cost you more. Whenever you want to make additional repayments there will be incurring penalties.

The introductory rates

It is an interest rate charged to a customer in the initial stages of a loan. The rate can be as low as 0%. It is not permanent and after it expires a normal or higher than normal rate will apply. Its purpose is to market the loan to customers.

• Introductory rate advantage; it can help you by freeing up some cash to help get your new home established.
• Disadvantages of introductory rate; there is generally a catch with introductory rates. After the end of the introductory period, when the rate returns to a variable rate, that rate will be higher than the discounted variable rate offered by the lender. Therefore, calculate whether the benefit of a reduced rate at the beginning is worth the additional cost of a higher rate later.

APRs & Comparison rates in Australia

The Annual Percentage Rate (APR) is the basic cost of your credit as a percentage of the total loan amount. Credit cards have several APRs with different roles such as one for purchases, one for cash advances and the one that is charged when you make late payments. However, a rate that includes all the fees is known as a comparison rate. A comparison rate helps you work out the real costs of a loan. It reduces the interest rate, most fees, and charges relating to a loan, to a single percentage figure.

How to calculate a comparison rate

The comparison rate is a percentage amount that is calculated by adding together the interest rate, plus any additional charges that may apply to the loan. After you have the total figure, you convert it into a percentage rate to highlight the true cost of the loan.

The importance of comparison rate

A comparison rate tells you a lot about a loan.

• Are the interest rate and comparison rate similar? In a case where a comparison rate is the same as the interest rate, it means that the lenders have no setup, ongoing and discharge fees.
• Is the comparison rate higher? When the comparison rate is higher, charges apply to the loan. When it is a bit higher, it means that there are only upfront fees. But a significant jump in rates could mean there are also ongoing fees.
• Is the comparison rate lower? Most lenders offer benefits to their borrowers which can reduce the interest rate over time, resulting in a comparison rate being lower than the interest rate.

The significance of APR

APR gives you a clear idea of the cost of the loan as a percentage. It is different from interest rates. However, for credit cards interest rate and APR might mean the same thing but not in loans. It is important to be aware of the APR you pay for any debt because it’s the price you pay to borrow the money.

The types of APR found in Australia

Loans have different types of APR. Its either you have a fixed APR or a variable APR.

• Fixed APR; means that the APR does not change based on an index during the life of the loan. Fixed APRs becomes more predictable when it comes to budgeting.
• Variable APR; the APR can change and is tied to an index interest rate, such as the prime rate published in the Wall Street Journal. When the prime rate increases, so would a variable APR. It fluctuates either in your favour or against it.

So, what exactly do you need to know about interest rates, APRs and comparison rates?

All these are important aspects of the financial sector. Although they sound similar, they are different from one another. Hence, it's important to know all of them before engaging in a financial discussion. In any of these, it is important to choose what perfectly suits your pocket, especially when you are applying for a loan.