Interest rates : facts and fallacies

Abstract

The purpose of this paper is:

1. to discuss the methods of calculating interest rates that are commonly used in New Zealand;

2. to present case examples showing the difference between quoted and effective interest rates for a number of major lending institutions; and

3. to generate discussion as to the need for effective interest rate disclosure legislation in New Zealand. In only one of the case examples presented is the interest rate quoted on an effective basis. In all other cases, except where no interest rate is quoted at all, the quoted rates are lower than the effective rates. In one case the quoted rate is less than half the effective rate. If the effective rates were reduced to the quoted rates then for some of the larger loans borrowers would pay several thousand dollars less in interest over the term of the loan. The advent of programmable calculators and desktop computers has greatly simplified the calculating of effective interest rates. This should facilitate both the implementation and enforcement of interest rate disclosure legislation. The major factor at present preventing the enactment of interest rate disclosure legislation appears to be the opposition of the financial institutions. It would seem that many of these institutions have a vested interest in maintaining the status quo.