Cutting Credit Costs

Sydney Morning Herald

Wednesday December 16, 1992

CATHERINE ARMITAGE

THE longed-for lift in the economy, which retailers hoped would send cash registers ringing for Christmas, has failed to materialise. Many families will be running tight budgets this holiday season, and paying for Christmas will demand some careful juggling of finances.

Taking out an unsecured personal loan from a bank, building society or credit union may be a sensible option for people in this situation.

One apparent advantage is that the interest rates charged on such loans are cheap compared with most credit card rates. As the table shows, a number of banks are currently quoting interest rates on unsecured personal loans of 13 to 15 per cent.

With most credit card rates ranging between 16.5 and 21 per cent, taking out a personal loan may represent an interest advantage of as much as eight percentage points.

However, before making such a financial undertaking, people need to be sure it is the best option. Obviously, the cheapest way to pay for Christmas is not to borrow at all but to use cash.

The temptation to splurge on family and friends at Christmas can be enormous, especially, perhaps, if it has been a year in which you have had to say "no" more than usual. But people who give in to the temptation and blow their household budgets over the next few weeks may spend the next year or so paying for a few days' gratification.

If paying for Christmas with cash is not an option, the next best thing is to use a credit card which has an interestfree credit period, and pay it off within the monthly billing cycle before interest charges are incurred.

Even if this is not possible, the credit card may still work out cheaper than a personal loan if it is paid off quickly. This is because, in contrast with credit cards, the repayment terms on bank personal loans are very inflexible.

When the loan is established, the interest cost for the full term of the loan is calculated and divided, along with the loan principal, into equal monthly instalments. It is necessary to pay the full amount of the instalments, even if the loan is repaid in full before the term has expired. Although there is no penalty charged for early repayment, there is little advantage to it, either. In certain circumstances a rebate of some of the interest component is available on early repayment. But people who are confident of being able to repay their Christmas debts within a few months probably are better off using a credit card, especially since the shortest loan term available from a bank is six months.

Since personal unsecured loans are available for terms of up to five years, it is tempting to opt for a longer term so as to minimise monthly repayments. However, this is not sensible because it blows out the total cost of the loan considerably.

For example, a $5,000 loan taken over 12 months at 13 per cent would incur credit charges of just under $360. The same loan taken over two years would incur almost twice the credit charges, at just over $705.

Another financing option for Christmas is a continuous line of credit, often called a personal overdraft facility.

Most major lenders offer them - for example, Westpac offers an overdraft with its Advantage Saver account, while St George has an Open Line product providing a continuous line of credit from $5,000 to $15,000.

For people assessed as good credit risks, a line of credit would be slightly more expensive than an unsecured personal loan, with interest rates around the 16 to 17 per cent mark. As with credit cards they have the advantage of flexible repayment terms, so you can pay them off as quickly as you like. The trap is that once you pay off some of what you owe, that amount again becomes available as credit.

As well, establishing such a line of credit may involve hefty fees, and the interest rate is variable. Setting up a continuous line of credit for the sake of Christmas would be like applying for a new credit card - creating a permanent credit temptation for the sake of a short-term need.

Interest rates on unsecured personal loans from banks and building societies are fixed. This means that the interest rate does not move up and down with changes in market rates but remains fixed at the rate agreed at the start of the loan.

By contrast, credit unions usually charge variable rates on personal loans. This means a borrower may start off with a loan at 13 per cent but, if general market rates move up, he or she may end up paying say, 15 per cent on the loan.

Either the monthly instalments will increase or the term of the loan will be extended.

But an advantage of borrowing from credit unions is that, in general, they are more flexible about repayment terms. Mr Alex Sala, the chief general manager of Endeavour Credit Union, explained that because interest was charged on a monthly reducible basis, people who paid off their loans early did not incur interest charges for the full term of the loan but only for the months in which they were still repaying it.

However, the terms and conditions of personal loans vary widely between different institutions. For example, unlike banks, which are prevented by the Credit Act from imposing fees or charges on unsecured personal loans on top of the interest rate, credit unions can. Most don't but some do.

Whether the loan is from a credit union, bank or building society, every borrower should read the loan contract carefully and make sure he or she understands it.

Inquire specifically about any fees and charges. Many institutions charge prohibitively expensive penalty interest rates if the borrower falls even slightly behind in repayments (the National Australia Bank starts charging penalty interest if a repayment is overdue by seven days).

Credit unions may lend as little as $500 but most banks and building societies have minimum loan amounts of $2,000. They prefer customers who need less than this to use credit cards, arguing that the administrative cost of setting up small loans is too high.

Maximum amounts available range from $10,000 (National) to $99,000 (ANZ)but this, of course, will depend on the lender's assessment of the customer's ability to repay.

As well, it is hard to imagine any bank making a $99,000 loan for the sake of Christmas.

Such large loans normally would be confined to purposes such as home renovation. Indeed, some lenders, including the Endeavour Credit Union, are reluctant to lend for the sake of Christmas at all, because they are concerned that people will overextend themselves. "We have a moral principle about promoting lending at this time of year," said Mr Sala of Endeavour.

The interest rate charged to a particular borrower also depends on the lender's partly subjective assessment of the ability to repay. Some banks(including the ANZ) charge higher interest rates for shorter term loans but others (including the National) charge slightly more for longer term loans. To the outsider, the setting of rates seems somewhat arbitrary.

Regular employment is a prerequisite for getting a loan. People who have a good employment record, who have been in a well-paying job for a long time and who are known to the lender as a long term customer will be charged the least, especially if they already have repaid a loan to the same lender.

Those who have been in and out of the workforce or who joined it only recently, who do not have a credit record, and are new customers, may not get an unsecured loan or find themselves charged at the higher end of the scale, around 18 per cent.

Some people who apply for an unsecured personal loan might be asked to supply security by the lender. This might involve pledging their house, or perhaps the car, against the borrowing. Normally, security would be required only from people who are not considered by the lender to be a good credit risk.

People in this situation should see whether they cannot get an unsecured loan from another bank, building society or credit union. (As a general rule finance companies are to be avoided because they charge the highest rates with the most onerous loan conditions.)

Those who cannot get an unsecured loan and, instead, face pressure to provide security, should ask themselves whether it is worth risking their assets for the sake of some extra Christmas spending.

 UNSECURED PERSONAL LOANS
         Interest  Minimum  Maximum     Min   Max
 Bank     rate %*     loan     loan    term  term
 Advance    16.5     2,000   20,000    1 yr  7yrs
 ANZ        14.4     2,000   99,000  6 mths  7yrs
 C'wealth     13     5,000   20,000    1 yr  7yrs
 NAB       15.75     1,000   10,000  6 mths  5yrs
 St George 14.75     3,000   20,000    1 yr  5yrs
 State      13.5     2,000  100,000**  1 yr  7yrs
 Westpac      16     2,000   15,000  6 mths  6yrs
 *  Lenders were asked to supply an "indicative interest rate for someone
assessed as a good credit risk." Where a range of rates was supplied the mid
point has been given. * * The maximum for the State provides an indication of
the likely limit for an unsecured loan as, officially, no maximum applies.

© 1992 Sydney Morning Herald

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