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Interest rates explained

Interest rates explained

Australian Lenders are obligated to undergo affordability assessments on all applicants before offering a loan. If you are planning on applying for a loan, we advise you first assess your own ‘affordability’ to ensure you are confident you will be able to make the repayments in the time period agreed. Compare your current financial income against your outgoings to understand what you’ll be able to repay on a monthly basis. When considering the loan amount you need, remember you will not just be repaying the principal (original amount borrowed) but also fees and interest accrued. In this article, we are going to provide some clarity on the types of interest rates offered by lenders and how these affect your repayments. Personal lenders typically offer either ‘variable’ or ‘fixed’ interest rates.

What is an Interest Rate?

If you owe money, the interest is a percentage of your balance that you pay as a ‘cost’ for the use of the money. Interest for loans is usually quoted as “p.a.” meaning “per annum” or “per year”.

Example: If you borrow $1,000 over 1 year with a 20% interest rate per annum, you will owe $200 in interest on top of the principal loan amount.

To understand the difference between the fixed and variable rate you need to know that the Reserve Bank of Australia sets the ‘cash’ interest rate, and this is reviewed on a monthly basis. Credit providers are able to set their own interest rates (in line with ASIC regulations) and can decide whether to alter their rates to align with the changing interest rate set by the Reserve Bank of Australia.

Variable Rate

If you agree to a variable interest rate with your credit provider, the interest rate you owe may increase and decrease as the Reserve Bank of Australia cash rate alters. It means that one month you may owe a different repayment amount compared to previous months.

The advantage of a variable interest rate is that if the cash rate decreases, the interest rate on your loan is likely to decrease. Additionally, there is usually no issues with additional payments being made allowing you to repay the loan early. Unfortunately, if the cash rate increases you will pay more interest. Some lenders may even increase the interest rate regardless to changes in the cash rate.

Fixed Rate

If you agree to a fixed interest rate loan, the interest rate you agreed is set for the loan term. This means that the interest rate you owe will not be influenced by fluctuations in the cash rate of the Reserve Bank. Your monthly repayments will not differ from one month to the next and you will be able to confidently plan your future finances.

Unfortunately, with a fixed interest rate, you will not be able to take advantage of decreasing cash interest rates. Furthermore, there are typically restrictions on additional or early repayments meaning you repay your loan early, at least without a fee.

By understanding the interest rates offered you will be able to properly compare credit providers. Remember though, the interest rate may not be the only sum of money (outside of the principal) you owe. For example, a lender may charge an establishment fee for opening up the loan account. Be sure to understand all the fees and charges associated with the line of credit before deciding on affordability. If you are approved for a loan, all fees and interest rates will be outlined in the loan agreement. We advise you read this thoroughly prior to signing so that you do not receive any unexpected costs.