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Comparison rate calculations

Discussion in 'Finance & Banking' started by JorgeBurgos, 19th Jan, 2009.

  1. JorgeBurgos

    JorgeBurgos New Member

    Joined:
    19th Jan, 2009
    Posts:
    1
    Location:
    melbourne
    Hi,
    This is a question for someone out there with access to a good comparison rate calculator... preferably someone who knows how the thing really works.

    I have put together my own calculator using the legislation found in this pdf doc: http://www.legislation.qld.gov.au/LEGISLTN/SLS/2003/03SL035.pdf, which is the only document I could find on the net.

    The formula on page 6 looks fairly straightforward once you interpret it: the left hand side is just the principal in most cases. The right hand side of the formula involves iterating through each payment period, adding up the repayments and fees that must be paid at each period.

    Anyway, I hooked up my calculator and it seems to be doing a good job. For the most part it gives the same results as the various other calculators out on the web, although there are some things my calculator handles that other calculators don't - such as residual (balloon) amounts and capitalization versus non-capitalization of fees.

    I noticed one thing strange though, which makes me wonder if I am doing something wrong.

    If fees are capitalized (i.e. financed in to the loan rather than paid up front), then one would think that the comparison rate should be higher, because the overall cost of the loan is higher. However, this doesn't seem to be the case. For some reason the comparison rate comes out lower when the fees are capitalized versus when they are paid upfront.

    Does anyone know if this is the correct behaviour?
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

    Joined:
    9th Jun, 2005
    Posts:
    4,623
    Location:
    Sydney, Australia
    How long is the period that you make comparisons over ?

    Capitalisation of expenses assists in short term costs while adding to long term costs - it is simply a deferral of the expense. If the comparisons are over the first 3 or 5 years of the loan, then I would expect the effective out-of-pocket expense for a loan with capitalised expenses to be lower than one in which you had to fork out for those expenses up front.

    ... while at the same time if you compared the same loans over the full term, you would indeed end up paying more for the capitalised expenses than you would for paying them off up front.