Mortgage repayment calculation question

TimM · 20-06-2008, 11:55 AM

Hello everyone, this is my first post here on Invested although I've been reading the forum for a while and have found it very helpful.

I was wondering if someone (maybe a mortgage broker?) could help me understand something.

I am currently looking into transferring my mortgage from ANZ to Suncorp. Suncorp is able to offer a lower interest rate (8.77% vs 8.97%), however based on their calculations, fortnightly repayments will be higher, all else (term of loan, payment frequency) being equal.

I don't understand how a loan with a lower interest rate can have higher fortnightly repayments. The banking manager at suncorp explained that it was due to differences in the way interest is calculated and how frequently it is charged, although this went over my head.

Is anyone able to explain this in plain language for me? It would be much appreciated.

Thanks

jrc77 · 20-06-2008, 02:06 PM

Just wanted to check if you are comparing fortnightly replayments for both loans?

JR

TimM · 20-06-2008, 04:10 PM

Yes I am.

Cheers

BV · 21-06-2008, 08:15 AM

ok same size loans but do you have an offset account
linked to the loan and have money in the offset?
Cheers

TimM · 21-06-2008, 09:58 AM

Quote:

Originally Posted by BV

ok same size loans but do you have an offset account
linked to the loan and have money in the offset?
Cheers

Yes, both loans will have an offset account linked, however the amount in the current offset account is small (approx $1000).

Loan is for $200,000 over 30 years, fortnightly repayments.

Even the calculators on the 2 banks websites give quite different results. $750/fn vs $790/fn.

Redwing · 21-06-2008, 11:33 AM

Whats the Comparison Rate?

Quote:

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 - Home Loans Now - A smart call: 1300 135 137.)

BV · 21-06-2008, 11:47 AM

Tim,

Is the loan interest only?
Because if it's not the repayment also includes payment against the principle.
Also, with offsets, some lenders with some particular loans they calculate the whole interest without taking into account the money in the offset.
Yes they charge less interest monthly against the loan but they deduct a higher amount from the offset and deposit it into the loan.
So the loan size is slowly being reduced.

Cheers

TimM · 21-06-2008, 05:02 PM

The loan is P&I.

Also, there's no fees with the new loan (staff benefit), so I don't think the comparison rate is applicable.

Could it be to do with how often the interest is calculated?

Still confused.

BV · 21-06-2008, 06:48 PM

Quote:

Originally Posted by TimM

Still confused.

Tim

Since it's a P&I loan and the difference is so small I wouldn't worry about it.
If it bothers you call your lender, they should be able to tell you what the interest component is.

Cheers

boringbanker · 23-07-2008, 11:18 PM

Hi Tim,

you will find that repayment amount will differ between banks due to the way their calculator is set. At the end of the day, what really important is the interest you pay, if your repayment is higher that just means that you're going to pay off the principle a bit sooner.

Btw.. banks normally don't take off set into account when calculating repayments.