What is the true cost of interest payments?

Trying to standardise the way that lenders charge interest and disclose their charges is one of the worthy aims of the Ministry of Consumer Affairs, currently embroiled in a Consumer Credit Law Review.

However, concerns raised about some of its proposals have prompted the ministry to call for more feedback. It's released a paper clarifying its particular proposals on interest charges and has asked for any further submissions by the end of this month.

What the ministry is essentially suggesting is that we adopt some elements of Australian law, which set the "daily rate" method of charging interest as the basic standard.

It says that one of the most important grounds for intervening in the consumer credit market is because of information difficulties faced by consumers, thanks to the multitude of ways that interest can be charged and disclosed.

"A flat rate, for instance, appears to be lower than an accrued rate: this has the potential to be misleading as well as raise information costs for consumers."

The ministry says some submissions it's received have expressed concern about the likely impact of such a regime on fixed credit, so it's clarifying just how this would work.

"The ministry's view, however, is that it offers significant advantages to consumers and will not necessarily harm lenders of fixed credit in the long term."

The ministry says the daily rate method (which involves applying a daily interest rate to the unpaid daily balance) is used in revolving credit contracts and for fixed credit contracts offered by banks, the larger mainstream finance companies and other mortgage lenders.

Other ways interest is charged include the flat rate method (interest is calculated as a proportion of the initial balance) traditionally used by small finance companies, cash loan companies and hire purchase sellers offering fixed credit; and the Rule of 78 (a way of distributing interest over the term of a loan) used by many hire purchase lenders.

It says some of these other methods have an unfair impact on early repayment or don't offer any benefits if consumers make extra payments.

Paul is a staff writer for Good Returns based in Wellington.

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