Article and follow-up column from last week, on how interest is paid on term deposits, and how not to be ripped off.
ARTICLE THAT APPEARED IN FRONT SECTION OF HERALD, FOLLOWED BY COLUMN
At a time when New Zealanders are borrowing more and more, the new credit act gives us less information about loans than in the past.
The government apparently decided that flaws in the old information rules were too hard to fix — despite the more than doubling of household debt as a proportion of income since 1990.
Household debt at the end of last year totalled $116 billion, or $29,000 per New Zealander, says the Reserve Bank. About 90 per cent of that is mortgages, although the mortgage total includes borrowing against houses to finance other spending.
The issue came to light after the Weekend Herald revealed, last week, that holders of term deposits receive infrequent interest payments unless they specify otherwise. This can leave people hundreds and sometimes thousands of dollars out of pocket.
While banks say they offer different interest payment schedules, many customers don’t recall being given such options.
One reader suggests New Zealand should copy the UK system, which requires lenders to publish “annual percentage rates” and issuers of term deposits and the like to publish “annual equivalent rates.”
These take into account not only interest charges but payment timing differences and fees. They make it easier to accurately compare different companies’ offerings.
New Zealand used to require a similar “finance rate” for loans, but not for term deposits and so on.
But under the Credit Contracts And Consumer Finance Act, which took effect on April 1, the finance rate is no longer required.
“Lots of people didn’t understand the finance rate,” says Graham Gill of the Commerce Commission. “And there appeared to be problems in the industry in calculating it, as some lenders included some fees and others didn’t.
“Now lenders put straight interest rates and fees separately.”
How this could be remedied? Read on.
QIn the UK anyone advertising an interest rate for either debit or credit must display both the rate they offer and the Annual Percentage Rate (APR) for debits or the Annual Equivalent Rate (AER) for credits.
The AER is the rate your get over a year if amounts are compounded. It is typically used for savings accounts where interest is paid monthly. It assumes all interest paid is left in the account and so the next month’s interest is paid on the previous months’ interest, compounding the amount.
Surely a simple change requiring financial institutions to publish both rates would be no burden while further educating people to the effects of compounding?
Generally the AER makes the contractual gross rate look more appealing, so it must be good for banks — unless they’ve got something to hide.
Your letter and the others below are in response to last week’s front-page article and column about how frequently banks compound interest they pay on term deposits.
Some banks do little compounding unless customers ask for it, which can considerably reduce interest received.
One of my first questions when I heard about that was: Are banks supposed to give would-be term deposit holders an equivalent to the finance rate, rather like the UK’s APR, which applies when we borrow money? That rate incorporates different interest payment schedules and other charges.
The reply, from Graham Gill of the Commerce Commission, is not only that there is no such requirement but, under the new Credit Contracts And Consumer Finance Act, the finance rate is no longer used when we borrow, because the concept wasn’t working well.
It seems to me, though, that we’ve thrown out the babe with the bath water. Perhaps we should get banks and other financial institutions to list charges separately, but quote interest rates that take into account the timing of interest payments for both money coming in and money going out.
QI live in the United Kingdom and have had a very substantial term deposit, comprising the funds from the sale of my New Zealand house, with the ANZ from April 1999 until November 2003.
The account was initially invested for three months, and regularly reinvested on maturity for varying periods of 3–12 months.
Never ever was it mentioned that I had a choice of how my interest would be calculated. I was told only that it was paid at maturity.
For a 12-month investment, in order to be able to compound the interest to a limited degree I had to persuade the ANZ to pay quarterly interest, which they only agreed to in exchange for a lower rate of interest.
By placing each quarter’s interest in a separate savings account, I was then able to earn more interest, but this was only on my own initiative. It was not suggested by the ANZ and my interest on the term deposit was never compounded.
I am very upset to read I should have had a choice. I am wondering what steps to take.
It doesn’t seem that ANZ neglected to give you a choice because, in your case, there was no choice.
While the bank offers varying payment options on term deposits of more than a year, it pays all the interest at maturity on shorter-term deposits.
It probably agreed to make an exception for you, paying the interest quarterly, because you were investing a large amount.
But that’s not its usual policy. And I don’t think it’s unreasonable that, in exchange, it paid you lower interest. After all, the bank lost the use of that money earlier.
Some other banks do offer more frequent payments on short-term deposits, but that’s not the point here.
ANZ made its offer, and you accepted it. You could have shopped around to see if you could do better elsewhere.
I hate to say it, but it might have made quite a difference on a large sum.
On a $100,000 one-year term deposit at 6.5 per cent interest, you would get $160 more, before tax, with quarterly rather than annual compounding.
On a similar $400,000 deposit, the difference is $640.
Note, though, that compounding is only one issue. ANZ may have been offering higher interest rates at the time, and that might have more than made up the difference.
For the benefit of others, ANZ doesn’t compound interest even on longer-term deposits.
Instead, it pays interest into an account nominated by the customer. The customer can reinvest that money in a new term deposit if it’s a large enough sum, or perhaps leave it compounding in the account.
This will be disadvantageous for weak-willed people who spend interest that would otherwise accumulate. And if the interest is small, you may not be able to earn as much on it as if it were still part of the term deposit.
But ANZ offers an online call account that pays monthly interest at an annual rate of 6.5 per cent on balances of more than $2000. This would suit some term deposit holders well. For one thing, it gives them access to the money on call if they need it.
Footnote: ANZ notes that, “We will always advertise the nominal rate, not the compound rate.” This is interesting, in light of today’s first Q&A.
The bank gives as an example its online call account. “The rate is advertised as 6.5 per cent, even though on an annual basis the compounded rate is 6.7 per cent. This negates comments that we pick and choose how we advertise.”
Fair enough. While I would rather see compound rates always used, consistent nominal rates are better than a bit of both.
QI read with interest your column on the front page of the Herald about the way banks calculate interest on term deposits.
I went one further with my bank.
I was quoted an interest rate on a substantial one-year term deposit. I can’t remember whether the information was volunteered by the bank or whether I had to ask, but I was told the interest could be paid annually or quarterly, and the quarterly interest could be paid to me or reinvested.
I next asked how the withholding tax would be calculated. I was told that if the interest was paid (or reinvested) quarterly, the law required the bank to deduct withholding tax from each quarterly payment.
I then suggested that the interest be compounded quarterly, but paid at the end of the year. Still, I was told, the withholding tax would have to be paid quarterly. I suspect that answer was more a function of the inflexibility of the bank’s computer systems than the requirements of the Income Tax Act.
My next step was to suggest that the quoted quarterly-compounded rate be converted to an equivalent annual rate, and the bank agreed. That way, I get the benefit of the quarterly compounding but pay the withholding tax at the end of the year.
It makes quite a difference in the outcome.
For example, a $100,000 deposit at 6 per cent a year produces $3,660 if the interest is paid at the end of the year and 39 per cent tax is deducted.
If the interest and tax are paid quarterly and the net amount is reinvested, the total net amount of interest is $3,711, an increase of about $50.
However, if 6.136 per cent (6 per cent compounded quarterly) is used and credited at the end of the year, the interest after tax is $3,743, more than $80 over the original amount.
These differences become about $90 and $110 for someone in a 19.5 per cent tax bracket, as a retired person might be.
Based on the amount I invested, the effort necessary to convince the bank to do it my way was well worth it.
AGood tip — for those with large term deposits.
On a $10,000 deposit, you would get only one tenth of the savings listed above — a mere $5 to $11. And for a $1000 deposit, we’re talking 5c to 11c. The banks wouldn’t be as accommodating with small amounts anyway.
But on a large deposit, as you say, it’s worth the hassle.
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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.