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AAPR

What is AAPR?

The Annualised Average Percentage Rate (AAPR) - commonly called (although not accurately) the comparison or true rate - is a calculation designed to approximate the actual cost of a loan, taking into account upfront fees, honeymoon rates, ongoing fees, different compounding periods and other factors. The calculation generally assumes a loan term of 7 years, and payments made as interest only, on a $250,000 loan. Unfortunately, we all have different loans, with different loan terms and different amounts.

Lenders do what they can to promote their loan products, and try to make them stand out from other lenders. For example, a lender may heavily promote an extremely low honeymoon rate for the first twelve months of the loan. This rate may be lower than other lenders' honeymoon rates.

Conveniently, the advertising may leave out fees, such as monthly fees, the lender's legal fees, valuation fees etc. When these fees are added in, customers may find they are better off with a higher interest rate and lower fees.

The AAPR is designed to take a number of these factors into consideration and provide a more accurate indicator of the cost of a loan than just comparing the advertised interest rates.

Comparing the AAPR of two similar loans will usually give a better idea of which one is cheaper than comparing the stated interest rates, but it does not tell you by how much. In fact, some customer groups and finance companies have been 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). When lenders use practices such as having deferred establishment costs, and other 'hidden' costs, (hidden so as they are not part of the parameters used by AAPR calculators), then AAPR can be an unreasonable indicator of the 'true cost' of a loan.

Using AAPR calculations can be complex. Once an 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 AAPR. A particular loan might have an AAPR of 6.5%, while a similar loan with a few additional features (e.g. redraw facility, portability and an offset account) might have an AAPR of 6.7%. Which loan is better? Whilst the first loan may be cheaper, if you want the extras, the second loan may be a better choice. You should decide which Loan Features you are looking for first, then start comparing those loans by their AAPR.

Thinking the loan with the lowest AAPR is always the better option is like thinking 'it's always better to buy a Hyundai Excel than a Holden Commodore because the Hyundai is cheaper'. What if your family size changes? What if you decide you would like to tow a caravan? What if you wanted to impress someone? The Holden Commodore will probably have the features you will want, and so it is probably the better buy. On the other hand, if price and fuel economy are the only consideration, the Hyundai may be the better choice. So too, with home loans.

Many lenders disagree with the idea of making AAPR disclosure mandatory in their advertising. They argue that the AAPR can't accurately take into account various 'freebies' and features they incorporate with the loan. As an example, how can portability, an offset account option or a redraw feature be part of an AAPR calculation? Additionally, what about discounts on other services or having fees waived on a deposit account?

A significant problem with AAPR is that the calculation is based on assumptions regarding the size, term and conditions of the loan. The further a customer's required loan varies from these assumptions, the less meaningful the AAPR will be. For example, the advertised AAPR calculation usually assumes the loan is for a seven year term, with a balance of $250,000. This may provide a very accurate cost comparison between different $250,000 loans which are for seven year terms.

What if the customer comparing AAPR wants a loan of $500,000? For larger loans, fixed-dollar costs such as monthly fees will be less important, as they are a smaller percentage of the total cost paid by the customer. The interest costs will be a 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 applies with the loan term. The shorter the period the upfront costs are amortised over, the higher the AAPR will be, all else being the same.

The bottom line is that - properly understood - the AAPR can be an 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, but it does have it's limitations, and is not sufficient by itself to accurately determine the True Cost of a home loan. In fact, some lenders deliberately manipulate some of their loan products to achieve a low AAPR which enables them to 'suck in' the uneducated borrower.

Fortunately, True Choice Home Loans has software that will help you come up with a true or comparison cost for the exact 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.

Determining which is the best value loan for your individual circumstances can be a difficult task by yourself. You will save yourself considerable heartache by allowing True Choice Home Loans to help you.