Retail Interest Rates for consumers or when is a ‘good deal’ too good to be true
Retail interest rates represent the rate of interest that an individual lender expects to be paid for a loan. Bank interest on ‘at call’ accounts could be between nil for a cheque account and 4.5% per annum on the top tier of Pensioner Deeming accountsat 10 December 2012. So what is a reasonable retail interest rate and when is a ‘good deal’ too good to be true?
When an item is loaned out the owner expects to be paid a hiring fee and to have that item returned in good condition on the agreed date. When an investor lends money, the interest charged is like a ‘hiring fee’ for the money loaned.
For example, if Irene lends $1,000 to Yvonne for one year then at the end of the year Irene expects Yvonne to pay her back the $1,000 together with a hiring fee called ‘interest’. Irene sets the hiring fee to compensate her for not having her $1,000 in cash throughout the year of the loan.
Retail interest rates include three components.
Interest rates include a component for compensation for lack of access to the money.
In our example, if Irene has lent her $1,000 to Yvonne then Irene cannot spend that $1,000 this afternoon on a replacement refrigerator.
Retail interest rates include only about 2% per annum for compensation for lack of access when the loan is for several years. If your money is accessible from an ATM then you usually do not get compensation for lack of access to your money (unless your money is in a Pensioner Deeming account).
Interest rates include a component for compensation for the potential loss of purchasing power of the money loaned.
Retail interest rates could include the projected rise in the CPI as reasonable compensation for retail investors’ loss of purchasing power.
In our example, Irene expects that when her money comes back, Irene could be able to purchase the same basket of goods that cost $1,000 today. By lending that $1,000 rather than buying the refrigerator today, Irene could expect to still buy an equivalent refrigerator later when her money comes back as well as being compensated for delaying her purchase.
Interest rates include a component for compensation for the potential loss of capital and/or failure to pay the interest payments in full and on time.
The level of compensation for the risk of not seeing all of your money again reflects the trustworthiness of the borrower.
Major Australian banks are trusted to repay their customers in full and on time.
Hence the retail interest rates offered by major banks allow for virtually no risk of losing your money.
In contrast, lending to the friend of a friend who wants to start an organic fruit farm carries a high risk of business failure and consequent non-repayment of the loan.
In our example, if Irene thought that Yvonne might refuse to repay the $1,000 then she might ask Yvonne to pay a higher rate of interest and have the interest paid each month so that she kept in contact with Yvonne.
In summary, retail interest rates could start at around 4% per annum for term deposits with major Australian banks for fixed terms of at least 3 years.
Offers of retail interest rates of more than 4% per annum in December 2012, might require the money to be loaned for many years with no early repayment option and/or carry a significant risk of not actually paying the agreed interest or failing to repay the full amount borrowed on the agreed date.
A December 2012 offer of 10% per annum for 3 years could include 6% per annum as an implied compensation for the real risk of losing your money.
Beware, if the retail interest rate offered appears very high then the deal could just be far too good to be true.
Hint Always read the offer documents carefully.
If the investment offer document is too complex for you to read or you can read the individual words but you cannot understand what it means then the financial product being offered could be unsuitable for you.
Always obtain professional advice before investing any money .
Ask a professional person to draft a loan agreement before you lend any significant amounts of money to anyone (family, friend or fortune hunter) . A good loan agreement could save you both money and friendships by avoiding later misunderstandings.
Disclaimer: The information contained in this website is of a general nature only and does not constitute “financial advice”. You should obtain your own personal financial advice before investing any money or moving in to any retirement village, lifestyle community or aged care facility. Financial Care Services is licensed to provide financial advice to individual clients based on their personal situations. © 2012 Financial Care Services Pty Ltd. All rights reserved.
To make an appointment for professional advice, call Financial Care Services (03) 9808 0338