Comparison rates are a tool that is designed to help borrowers understand the real cost of their car loan, and compare different loan options quickly.
While well intended, the number can still be misleading when trying to find the best car loan for your situation.
A lower comparison rate may not mean a cheaper car loan. In this article, we will discuss what comparison rates are for car loans, why the exist, and what you need to know to recognise a misleading number when you see one.
In This Post:
Interest Rate vs. Comparison Rate Car Loans
When shopping for your new car loan you are likely to come across ads or information pages online that have both an interest rate and a comparison rate linked to the same loan.
A common mistake consumers make is to look only at the interest rate when comparing financial products.
The comparison is (usually) far more telling.
What is an Interest Rate
The interest rate is the annual percentage of the loan balance that the lender charges in return for providing you the credit.
It is a concept broadly understood so we won’t dwell on it here. What is not well understood is what is a good interest rate, and how that represents the full cost of a loan.
This is where comparison rates come in.
What is a Comparison Rate
The comparison rate is intended to represent the all-in cost of the loan, turned into an annual percentage rate for easier comparison between loan products.
All costs associated with the provision of credit must be included in the comparison rate.
This includes monthly fees and establishment fees which can vary significantly between lenders.
Interest Rate vs Comparison Rate Example
Let’s look at two lenders offering a car loan of $30,0000 over 5 years.
- Lender A charges 12% interest and a monthly fee of $5 a month.
- Lender B charges 11% interest and a monthly fee of $28 a month (yes some lenders charge this much)
If you are only paying attention to the interest rate then Lender B is clearly the better deal. But what does the comparison rate say?
- Lender A – 12.33% comparison rate
- Lender B – 12.85% comparison rate
We will revisit this example later in the article, but I hope that you can already recognise the value in this calculation.
The brokers at Gusto Finance always consider the total cost of a car loan when matching you with a lender. To start a conversation and understand your options click the button below to inquire.
Why Comparison Rates Exist on Car Loans
Comparison rates exist to provide a quick and easy way for consumers to compare the true cost of a loan product.
What a considerate way for lenders to present their products to the market, right? Well, not exactly…
Why Australian Lenders Must Disclose a Comparison Rate
Australian lenders are legally required to disclose a comparison rate under the National Credit Code.
These standards are upheld by ASIC who state in its guidance that:
“where a credit advertisement contains an interest rate, it must also contain a comparison rate which is not less prominent than the interest rate“
This regulation was introduced to ensure greater transparency in the lending market, protecting borrowers from misleading advertising tactics.
By mandating comparison rates, financial regulators aim to make it easier for consumers to compare loans on a level playing field.
While well-meaning, the unfortunate reality is that many consumers do not understand comparison rates.
Advertised Interest Rate Could Be Misleading
At Gusto Finance we are frequently asked about interest rates by our clients. But this is never the whole story when it comes to the cost of your loan.
A low interest rate will catch someone’s attention. But there is so much more to consider if you are looking for the cheapest loan option that you can obtain.
What is Included in the Comparison Rate?
A comparison rate will include all of the fees associated with setting up and managing the loan.
There is a host of fees that some lenders may charge you that must be included in the comparison rate.
This list of fees will vary between lenders, and the amounts can also vary:
- Application Fee
- Establishment Fee
- Risk Fee
- Monthly Account Fee
- Broker Fee
What is not Included in the Comparison Rate?
There are some fees not included in the comparison rate that could be payable as part of the loan but are not associated with the provision of credit.
These are usually to deal with additional administrative events that are within the borrower’s control
These fees may include:
- Late Payment Fee
- Payment Rescheduling Fee
- Reversal Fee
- Penalty Interest (when in arrears)
- Early Repayment Fee
These fees can be avoided if you stick to your loan agreement for the life of the loan.
Comparison Rate Calculation
The comparison rate calculation is influenced by the loan term and loan amount, and not just the size of the additional fees payable.
In this section, we will look at some examples for each of these car loan parameters.
Loan Terms and Comparison Rates
Let’s return to our previous example where Lender A was the cheaper option (12.33% comparison rate).
In this case, we will include a $1,000 establishment fee and compare loan terms of three years vs five years.
- 3 Year Term – 14.73%
- 5 Year Term – 13.84%
As you can see, the shorter loan term has a higher comparison rate. This is due to the upfront cost when opening the loan.
The $1,000 establishment fee is a cost associated with the provision of credit that is not reflected in the interest rate.
To calculate the comparison rate you must add up the cost of the interest rate + monthly fees + establishment fee, and spread that cost out over the loan term.
A shorter loan term means more of that cost is incurred in each year of the loan, leading to a higher comparison rate.
Loan Amount and Comparison Rates
Using the five-year loan term in the above example, we will now compare a $30,000 loan vs a $40,000 loan.
All other fees are the same.
- $30,000 Loan – 13.84%
- $40,000 Loan – 13.37%
The comparison rate is lower for the larger loan size because the fees are compared to a larger number. The cost is the same in terms of dollars but as a percentage of the balance it is smaller.
Does a Lower Comparison Rate Mean a Cheaper Loan
A lower comparison rate does not mean the cost of the loan will be cheaper.
Every example in the previous section had a lower comparison rate for the more expensive loan. This is why it is so important to understand how a car loan really works.
For easy comparison, let’s look at the total cost of credit for each example.
Loan Term Example
Despite the lower comparison rate, over the life of the loan, you will save $4,289 if you repay the loan in three years.
- 3 Year Term – $7,051
- 5 Year Term – $11,340
Loan Size Example
This example is less surprising considering you are borrowing an extra $10,000. Nevertheless, you will save $3,347 with the smaller loan despite the higher comparison rate.
- $30,000 Loan – $11,340
- $40,000 Loan – $14,687
Need Help with Comparison Rates?
If you are still a little confused then that’s ok – this can be a tricky thing to understand!
Our expert broker team can walk you through your options for auto finance and help you fully understand the total cost of your loan before committing.
Just click the button below to get started.
Conclusion
Comparison rates are a great tool to help you select a car loan that is suitable for your situation. But as you can see, it is not the whole story.
While you now have a better understanding of what goes into these calculations, you still have to shop around to be sure you are getting the best loan for your circumstances.
You can save yourself time by having Gusto Finance do all the legwork for you. So get in touch today and we will find you a great deal!
