04-300 No credit for misleading loan calculators
Thursday 16 September 2004
The Australian Securities and Investment Commission (ASIC) has acted to close down loan calculators on more than 100 websites of Australian financial institutions, including banks, credit unions, other lenders and finance brokers.
The calculators suggested that using a line of credit will result in the consumer paying off their home loan more quickly.
‘Most lines of credit charge higher interest rates than standard home loans, so when you stop to think about it, it was extraordinary to suggest that paying higher interest could pay off a loan sooner’, said Mr Greg Tanzer, ASIC’s Executive Director of Consumer Protection and International Relations.
The loan calculators produced a graph, comparing the time taken to pay off a standard loan with the time taken using a line of credit.
However, the way the calculator was designed meant that:
‘If financial institutions try to sell loans to consumers, such as lines of credit, through flawed comparisons, consumers may be misled into believing that there is something special about lines of credit which mean that you will own your own home sooner. That’s not true,’ Mr Tanzer said.
‘The only way to pay off your loan sooner is by moving to a loan with a cheaper interest rate or by making extra repayments. In fact, if you can afford to make extra repayments you will probably save just as much by making those payments on your existing loan, and you can avoid extra costs, such as early repayment penalties and application fees, by not refinancing,’ Mr Tanzer said.
‘The calculator software was produced by infochoice.com.au in line with industry specifications, and was used by over 100 lenders and broker groups.’
‘infochoice.com.au acted quickly to take down the calculators from over 100 websites once ASIC raised these concerns with it,’ Mr Tanzer said. ‘ASIC acknowledges the company took a co-operative and responsible approach that will benefit consumers.’
- extra repayments were credited to the line of credit but not to the standard loan;
- the line of credit was at the same interest rate as the home loan; and
- these assumptions were not made clear to the consumer, so that the calculator showed that the line of credit was paid off more quickly than the home loan but it was not clearly stated that this was due to higher repayments by the borrower.
Line of credit mortgages are generally interest-only loans with no set term for the loan to be repaid. The borrower then has the freedom to choose when they will make payments on the principal. Lines of credit may be good for people who have fluctuating incomes and may sometimes be able to make additional payments, but would also at times be unable to meet the normal repayments on a standard loan. They suit people who need a great deal of flexibility and can afford to pay a higher rate of interest. Borrowers who are not disciplined in their use of credit face the risk of only paying the interest each month, so that the balance of the loan never reduces.
A line of credit may also allow borrowers to make the bulk of their purchases or payments through a credit card with an interest-free period. This means that the borrower’s salary can sit in their loan account in the period between the date of purchase and the date of payment of the credit card. This mechanism slightly reduces the balance of the home loan debt for part of each month and therefore slightly reduces the interest payable. These types of savings are called offset savings. The credit card will be paid off each month by using your funds from the line of credit. The offset savings achieved for most people will be minimal.
The extent to which borrowers can repay their loan more quickly usually depends to a far greater extent on their capacity to make additional repayments, rather than through offset savings. Generally, borrowers who cannot afford to make significant additional repayments will be worse off refinancing to a line of credit, because a line of credit will usually have a higher interest rate and the higher interest charges may outweigh any offset savings.
ASIC is aware that some finance brokers promote the use of lines of credit as part of ‘debt reduction’ schemes. These schemes encourage borrowers to refinance to a line of credit with calculations, charts or graphs showing the balance of the line of credit reducing more quickly than the consumer’s existing loan. These calculations or charts may result in exaggerated claims about the amount of money consumers can save, where the broker makes unrealistic assumptions about the capacity of the borrower to make additional repayments.
ASIC’s consumer website FIDO at www.fido.asic.com.au has more information about loans and lines of credit.
ASIC Website: Printed 09/01/2014