Interest rate is often the first thing that catches your eyes when comparing home loans. But it doesn’t tell you the full story. Comparison rates,on the other hand, are more accurate.
Banks and Lenders are obligated to display a comparison rate along with their advertised loans. And these rates factor in hidden charges that might be overlooked.
But what constitutes a comparison rate, and how useful is it when you’re trying to find the best deal. Let’s break it down.
What is a Comparison Rate?
A comparison rate is a legally required figure that shows the true cost of a home loan. It combines the interest rate with many of the upfront and ongoing fees associated with the loan giving you a more realistic idea of what you’ll actually pay.
Simply put, comparison rate helps you compare apples with apples.
For instance,
- Loan A: 4.89% interest rate, 5.55% comparison rate.
- Loan B: 5.09% interest rate, 5.09% comparison rate.
Loan A looks cheaper but may cost more overall.
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How does Comparison Rates Work?
A comparison rate works by combining the advertised interest rate on a loan with most of the fees and charges associated with that loan, then expressing the total cost as a single percentage. This percentage is intended to reflect the true annual cost of the loan over time, making it easier for borrowers to compare different loan offers.
When calculating the comparison rate, lenders take into account:
Interest rate: This is the actual interest rate that lenders charge and can affect how much you will be able to borrow.
Fees and Charges: Lenders may charge additional fees such as a monthly account fee, establishment fee, valuation fee and settlement fee. These fees can have a significant effect on the loan cost.
Loan term: Lenders usually calculate your repayments using amortisation (paying off the debt over time) which takes into account the loan term and the interest rate. Note that the comparison rate is usually calculated for over 25 years, although standard home loans last for over 30 years.
Loan amount: Some banks may offer a discounted rate on bigger sizes. This means that the comparison rate can be lower for bigger loan amounts.
Payment frequency: Making frequent repayments can lower the outstanding balance on the loan on a more regular basis. This can reduce the overall comparison rate.
Why Comparison Rates Matter When Choosing a Home Loan
Most lenders advertise an introductory or “honeymoon” rate that seems cheap but revert to higher rates after 1-2 years.
A comparison rate cuts through that marketing and shows what you’ll likely pay over the loan period. So, you can use it to:
- Avoid sneaky hidden fees
- Spot expensive loans
- Compare multiple lenders
Still, they don’t rely on it alone. Features such as redraw facilities or offset accounts can help reduce interest over time.
How to Use Comparison Rates?
There are ways to properly use comparison rates. Here’s what you should keep in mind:
- Use comparison rates as a first filer and not the final word
- Always check both interest rates as well as comparison rates
- Ask your broker to explain the large gap between the two rates
- Learn how loan features affect your actual repayment
For example,
| Loan Feature | Lender A | Lender B |
|---|---|---|
| Advertised Rate | 4.89% p.a. | 5.09% p.a. |
| Comparison Rate | 5.55% p.a. | 5.09% p.a. |
| Annual Fee | $395 | $0 |
| Offset Account | Yes | No |
In this case, Lender B may be the cheaper long-term choice, even though the interest rate is slightly higher.
Can comparison rates help me get a better deal?
Although comparison rates are a way to force lenders to present the true cost of a loan, these figures are often inaccurate and unreliable.
The reason is that lenders generally don’t include certain factors when calculating the comparison rate, such as government stamp duty and break costs.
This can cause misunderstandings amongst borrowers and may lead them to take out a loan that they cannot afford.
What the Comparison Rate Doesn’t Tell You?
Comparison rates may not tell you the complete picture. They don’t factor features such as:
- Extra repayment flexibility
- Interest-only options
- Portability between properties
- Ability to split between fixed and variable rates
So, after you’ve locked down your rates, the next thing you need to explore are the loan features.
Generally, lenders take into account a number of factors when calculating a comparison rate.
Some of the things that they may not take into account include:
- Lenders Mortgage Insurance (LMI): LMI is a fee charged if you’re borrowing over 80% of the property value. The comparison rate doesn’t include LMI when calculating their comparison because the calculation is usually based on 80% LVR (Loan to Value Ratio) or less.
- Stamp duty and other government fees: Government fees and charges, such as stamp duty, aren’t included in a comparison rate. You can use our Stamp Duty Calculator to find out how much stamp duty you’ll need to pay.
- Conveyancing fees: You may need to hire a conveyancer or solicitor when applying for a home loan.
- Redraw fees: Some lenders may charge a redraw fee if you want to redraw during a fixed rate period.
- Break fees: This cost may apply when you terminate a fixed rate home loan before the fixed term ends.
Final Words
Comparison rates cut through the noise of shiny interest rates and reveal the actual loan cost so you can understand lender fees that you would otherwise ignore. But that’s not the entire story.
The rates are based on set loan size and term, and they don’t cover everything such as stamp duty or Lenders Mortgage Insurance. So while they’re a great starting point, they’re no crystal ball.
To truly compare loans, match the numbers to your situation. Better yet, let us crunch the numbers for you. Call 1300 889 743 or hit up our free online assessment, we’ll help you find the loan that actually fits.