Last time we discussed the reserve bank cash rate and its effect on commercial interest rates, as well as how interest rates affect your savings deposits.
Next up we’ll take a look at how interest rates affect your borrowing from the bank, a little more complicated than deposits but well worth investigating as the rewards for being in the know could be worth thousands of dollars in your pocket.
While interest rates define how much you would earn on a deposit of cash to your bank, in the case of credit cards, home loans, personal loans and even car loans, the interest rate is how much the bank will charge you for borrowing money.
Credit cards can be a quite tricky when it comes to interest rates as there is often more than just one type of interest that you’ll need to look out for. Here’s a quick look at the main categories you will usually find.
This is the ongoing interest rate that you will be charged when borrowing credit to make regular purchases such as paying for the groceries or filling up the car. Purchase rates can range from below 10% to over 20%, usually depending on the services the card offers such as rewards and of course the charges by the lender.
Example: You make a $300 purchase on your credit card with a 18.99% purchase rate and pay back just $30 a month. According to Mozo’s Health Check Tool it would take you 11 months to pay off your balance, plus you would be charged $79 interest (including the $50 annual fee), making the full price of your purchase $379.
But remember if you pay off your balance before the end of your card’s interest free days, you won’t be charged any interest at all.
Balance Transfer Rate
When taking out a new credit card you may be offered a balance transfer rate. This allows you to bring over the unpaid balance on your old credit card to the new card at a reduced rate for an introductory period. This is a great way to consolidate and catch up on debts that may be spiralling out of control. But beware, once the balance transfer period ends, the interest rate will often revert to the credit card’s much higher cash rate so it is always a good idea to pay off your balance during the intro period.
Example: Making monthly repayments of $300 on a balance of $5000 with a 18.99% purchase rate and $50 annual fee, would take around 1 year 8 months to pay of and incur a total of $951 on fees and interest.
Carrying the balance over to a new credit card with the exact same rates and fees but with a 0% balance transfer rate for 12 months, paying off your balance would take just 1 year and 5 months and cost just $166 in interest and fees. That’s a saving of $785!
Cash advance rate
This is the interest rate you will be charged for withdrawing cash out of the ATM using your credit card. With cash advances interest is charged from the day you make the withdrawal. It’s best to avoid doing this because the cash rate is often well above 20% and usually has no interest free days.
Here’s a few top credit cards from the Mozo database to help give you the right idea.
Home loans, personal loans and car loans
Loans can be a little bit easier to grasp than credit cards, with three basic interest rates to take note of.
A variable loan means that the interest rate will change according to the Reserve Bank cash rate we spoke of in part one and when the commercial banks decide to change their rates. When interest rates are cut, generally the rate at which the bank will charge you for borrowing should go down as well, making your loan cheaper.
A fixed interest rate is, as the name suggests, fixed for a period of the loan. So no matter what happens with the cash rate, your repayments will stay the same. Fixed rates are good if you have a sneaking suspicion that the official cash rate is about to go up and loans are about to get more expensive. But beware you could run into ‘break costs’ if decided to terminate the loan or pay it off early.
You will notice that with every loan advertised, in addition to the fixed or variable interest rate providers will also show a comparison rate. This rate is a useful tool that shows you the true cost of a home loan or personal loan. The comparison rate takes into account introductory and ongoing interest rates, upfront fees, any ongoing fees and other factors not included in the ‘headline’ rates advertised by lenders. This helps you compare loans side by side, as a loan with a really low first year introductory rate might work out to be more expensive in the long run than a loan with a low ongoing rate.
Here’s a few top variable and fixed rate home loans from the Mozo database to help give you the right idea:
Secured vs. unsecured.
One last aspect to consider that can have a large impact on the interest rate of a personal loan is whether the loan is secured or unsecured. An unsecured loan is where you the borrower have no collateral or personal assets of equal value to the loan that you can offer to the lender as security in the circumstance that you cannot repay your loan. And in this case the lender will usually charge a higher interest rate due to the higher risk of the loan.
So for a personal loan of $15,000 for 3 years, you could expect to pay as much as $482 more on interest for an average unsecured loan of 13.38% compared to the average secured loan interest rate of around 9.76%.
Check out this example of the different rates on secured and unsecured fixed rate personal loans:
Not all loans are created equal.
There is just one last lesson to be learned. Now you know why your interest rates go up and down and how it’s going to affect your pocket, the last thing to take note of is this: Not all lenders have the same interest rates. The fact is that you can often find products that offer similar services but but at different costs to you the borrower. So take a little time to do some homework on Mozo and hunt down the best products with the lowest interest rates, fees and charges.
Still have an unanswered question on interest rates? Feel free to leave a question in the comment section below.