The
Annualised Average Percentage Rate (AAPR) - also known as the
comparison or true rate - is a figure designed to show the 'true'
cost of a loan, taking into account upfront fees, honeymoon rates,
ongoing fees, different compounding periods and other factors.
From a marketing perspective, lenders need to have some 'point
of difference' to promote in their advertising to make their loan
products stand out from those of their competitors. For example,
a company may heavily promote an extremely low honeymoon rate
for the first twelve months of the loan. This rate may be lower
than their competitors' honeymoon rates.
But what if this loan has a monthly fee and the competing products
don't? When this fee is added in, consumers might be better off
with a slightly higher interest rate and no monthly fees.
The AAPR is designed to take all these factors into consideration
and provide a more accurate indicator of the cost of a loan than
simply comparing the advertised interest rates.
To some extent, it does. Comparing the AAPR's of two similar loans
will typically give a better idea of which one is the cheapest
than comparing the stated interest rates. In fact, some consumer
groups and finance companies are calling on the Government to
introduce legislation making it mandatory for lenders to disclose
the AAPR in all loan advertisements where an interest rate is
stated. This is probably a good idea... if consumers are educated
to understand what the AAPR is and to interpret it meaningfully.
AAPR calculations are very complex. Determining which loan really
is the cheapest is a difficult task, even with the help of an
expert mortgage broker who can calculate the AAPRs of different
loans. And even if the AAPR is accurately determined, the cheapest
loan is not necessarily the best loan. For example, some no-frills
loans have low interest rates, no fees and low AAPRs.
One such loan might have an AAPR of 6.5%, while a similar loan
with a few additional features (e.g. redraw facility, portability
and a chequebook facility) might have an AAPR of 6.7%. Which loan
is better? Well, the first loan is cheaper, but if you need the
'frills,' the second loan might be the best option for you.
Saying the loan with the lowest AAPR is always the better option
is like saying it's always better to buy a compact car than a
luxury sedan because the compact is cheaper. The fact is, the
more expensive sedan will probably have quite a few more features,
and if you really want these features, then it's probably the
better buy. On the other hand, if price is the primary consideration,
the compact may be the wiser choice.
Many banks and financial institutions are opposed to the idea
of making AAPR disclosure mandatory in advertising. Their argument
is that the AAPR can't accurately take into account various 'freebies'
and features they might throw in that can be difficult to quantify...
for example, how can portability, a chequebook option or a redraw
feature be brought into an AAPR calculation? In general, they
can't.
Another problem with AAPRs is that the calculation is based on
a given set of 'assumptions' about the size, term and conditions
of the loan, and the further an individual's required loan varies
from these assumptions, the less meaningful the AAPR figure will
be. For example, the advertised AAPR calculation may assume the
loan is for a seven year term, with a balance of $100,000. This
may provide a very accurate cost comparison between different
$100,000 loans which are for seven year terms.
But what if the person reading the AAPR figures wants a loan of
$300,000? For larger loans, fixed-dollar costs such as monthly
fees will be relatively less important, as they'll be a smaller
percentage of the total costs paid by the borrower. The interest
costs will be a much greater factor, with the interest rate playing
a more important role in the AAPR calculation. Conversely, with
smaller loans, upfront and monthly fees will have a greater influence
on the AAPR.
The same goes for the term of the loan... the shorter the period
the upfront costs are amortised over, the higher the AAPR will
be, all else being equal.
The bottom line is that - properly understood - the AAPR can be
an extremely useful tool for comparing loans and cutting through
'marketing hype' that focuses only on single aspects of the loan
such as honeymoon rates, no upfront fees, etc. In fact, better
mortgage brokers will have software that will help you come up
with a true or comparison rate for the size and term of the loan
you actually require. This can provide an even better way of ranking
loans and finding the loan that's the cheapest in your particular
circumstances, yet still gives you whatever additional features
you need in a loan.
(By Tricia Green, Home Loans Now - www.homeloansnow.com.au.)
