In the interest of interest

We all know how to explain interest charges to our clients when it comes to a property loan. It’s safe to say that if we don’t, then we might be in the wrong industry! Various cashflow/Fintech/online lenders emerging in the industry, however, have resulted in changes to the way we’ve traditionally seen interest rates reflected across the market. Suddenly, we are hearing about Factor Rates, Annual Percentage Rates (APR’s) and Simple Rates. So why the change and what’s the difference?

Let’s explore the various interest models, how to compare them and most importantly making sure we are providing our clients with a clear picture of what they’re signing up to. What are the various ways you may see interest reflected?

Let’s start by looking at home loan rates. When we talk with clients about home loans and associated rates, we are most commonly dealing with Comparison Rates. In asset finance, think of Annual Percentage Rates (APR) as a home loan Comparison Rate. An asset finance APR is different to a home loan APR as asset finance loans are fixed term and fixed rate.
 
An asset finance APR represents the total cost of funds over a 12 month period, expressed as a percentage. This includes compounding with all fee’s and charges. It is the inclusion of all associated costs expressed as a percentage that makes the APR different from the interest rate which will not include the associated loan fees. The differences are simple. APR reflects the real cost of the loan whereas interest rate just calculates the interest you will pay. 

A Factor Rate is not an interest rate as it is displayed as a decimal and is usually somewhere between 1-2. This figure multiplied by the loan amount will dictate the cost to pay back the loan. With the rise in popularity of unsecured working capital loans and the financiers who provide them, Factor Rates have become more common.
 
For instance, a loan amount of $50,000 with a factor rate of 1.25 minus the total repayments will be $75,000. You may think this calculates to rate of 50%, however, this is not right. Because the interest component on this facility type is charged upon settlement,  the application will settle and the approval limit is made available. Next, the facility will be created for the total principle amount as well as total interest charges over the life of the facility. Be mindful that there will be no interest savings if your clients make additional deposits as it’s already been calculated up front.

Like its name suggests, simple interest is an easy method of calculating the interest charged on a loan. Simple interest is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments.

To give you an example of simple interest we have included an example below of a borrowing amount of $50,000 over a 24 month term at a simple interest rate of 1% per fortnight. There will be a total of 52 repayments and you can see the difference in principle and interest component changing despite the repayment amount remaining the same.

 

Recognising the various models is the first step, now we just need to make sure we can identify this when pricing and how to then quote comparatively.

The good news is that with so many new lenders entering the market there have been subsequent changes to the way we calculate and view rates. For example,  the launch of a small business pricing disclosure called SMART (Straightforward Metrics Around Rate and Total Cost) Box. The SMART Box is focused on empowering small businesses to better assess and compare finance options.

SMART Box originated in 2016 when three of the largest online lenders came together to develop a code of ethics for the industry. The purpose is to help borrowers answer these three vital questions:

This tool has been created to allow you to comparatively quote, understand and explain the various interest rates and loan costs whilst providing clients a clear picture of potential future obligations across the various institutions.
 
Loan contracts issued with participating lenders will now all include a copy of the SMART Box tool within the documents. You can find examples of the tool as well as additional information around SMART Box and the code of ethics through this link here. 

To leave you with one piece of advice, remember and educate your clients on the 4 R’s: Rate, Risk, Return on investment and Reward. Often clients get stuck on the rate, however, the higher the risk the higher the cost of funding. We endeavour to find solutions for start-up businesses, unsecured funding and poor credit ratings, unfortunately though, as the risk increases the rates can follow suit.
 
You should urge them to think about the return on investment. If our business clients are seeking funds to expand, purchase stock or assets and the funding will make a profit, even once we have subtracted cost of funding, then regardless of how high the rate, it’s still a worthwhile investment. Lastly, we have reward. Just as the name indicates, have a chat about the purpose of funds. If clients see the benefit as greater than the costs, then the reward speaks for itself. Don’t let rate dictate!

Happy to help.

If you are looking for a solution to assist your consumer and commercial clients with all asset, equipment and cash flow finance solutions - but don’t yet have the knowledge and can’t justify the high costs associated with multiple accreditations, specialist systems or a full time specialist on the payroll – then NLG Leasing is the right business partner for you. If you would like more assistance, please contact the NLG Leasing team on 1300 722 011 or email support@nlgleasing.com.au