Learn how to avoid the confusion between interest rates and comparison rates on your next home loan.
Most people barely notice when banks advertise an interest rate and then they display a comparison rate below this in brackets. The ads tend to display a really cheap interest rate in huge font, but that comparison rate in brackets if often much smaller and less significant. In fact, many people aren’t even aware of what the comparison rate really means. They simply focus on the interest rate they see advertised and believe they’re getting a good deal.
Yet, the comparison rate was introduced as a way to force banks and lenders to take accountability and be honest about the actual costs of a loan. This stops them from falsely advertising too-good-to-be-true interest rates and forces them to inadvertently disclose any hidden fees that otherwise wouldn’t have been noticed.
Australian Home Loan Comparison Rates
Table of contents
What is the comparison home loan rate?
What’s the difference between the interest rate and comparison rate?
How do lenders calculate the comparison rate?
What isn’t included in the comparison rate?
How important is the comparison rate?
When will you find comparison rates?
How do you calculate the comparison rate?
Do the comparison rates calculate everything?
Examples of Comparison Rates
Comparison Rate FAQ
Top Tips
What is the comparison home loan rate?
The comparison rate is a government mandated requirement for all lenders that they more accurately display the true cost of a home loan. This was an overt attempt to stop lenders from advertising incredibly low interest rates that lured unsuspecting borrowers into home loans that actually cost them far more than they expected.
For example: if a lender advertises in bold font that their mortgage interest rate is only 5.15%, you’ll find a much smaller comparison rate displayed somewhere on the same advertisement. If that lender charges additional fees and charges associated with that loan, the comparison rate is more likely to be around 6.25%. This gives you a much clearer idea of the real cost of that home loan.
What’s the difference between the interest rate and comparison rate?
The interest rate is the percentage amount most people take notice of when they try to compare home loans. This is the percentage of your loan that you’ll end up paying in addition to the original loan amount.
The comparison rate is a percentage amount calculated by adding together the interest rate, plus any additional fees and charges that may apply to the loan. The total figure is then converted into a percentage rate to highlight the true cost of the loan. Lenders are unable to hide any fees, charges or other costs, as these are reflected in the overall comparison rate.
If you aim at comparing home loans from different lenders by focusing only on the interest rate, you may end up paying far more than you think. However, if you base your research on the comparison rate, you’ll get a more accurate idea of the true cost of the loan. This will also help you find a far more competitive deal.
How do lenders calculate the comparison rate?
The comparison rate is calculated using a formula that takes into account a number of items. These include:
Interest Rate
The actual interest rate charged by the bank for your home loan is a major factor in calculating the comparison rate.
Fees and Charges
Many lenders charge a monthly account fee for their mortgage accounts. Some might charge an annual package fee. Some may also charge an establishment fee, valuation fee, mortgage documentation fee and settlement fee. These charges need to be taken into account when calculating the comparison rate, as they do affect the overall cost of the loan
Loan Term
The actual term the loan is extended for will play a part in determining the comparison rate. Your repayments are calculated using amortisation, which takes into account how long the loan term is and what the interest rate is. When working out repayments, a longer loan term can mean lower monthly repayments.
However, a longer loan term also means more opportunity for the bank to earn more interest. When it comes to calculating comparison rates, a longer loan term will mean a higher comparison rate. If you see a comparison rate calculated over 25 years, ask to have it reworked to reflect a 30 year term, if this is how long you intend your mortgage to be set for.
Loan Amount
The actual loan amount will also be a factor in calculating the comparison rate. Some banks actually offer discounted interest rates on larger loan amounts, so the comparison amount may actually be lower for a bigger loan amount.
Payment Frequency
The interest on your mortgage is calculated on the outstanding balance every day. This means paying your repayments more frequently will actually reduce the balance on a more regular basis, which can reduce the overall comparison rate.
What isn’t included in the comparison rate?
Multiple factors are taken into consideration in an effort to reveal the true cost of a loan and arrive at a comparison rate. Unfortunately, there are some costs that won’t be included in the calculations, even though they are costs that can affect how much your mortgage costs overall.
These charges include government stamp duty, even though this amount may affect your total mortgage amount.
Other charges that cannot be calculated accurately for comparison rate purposes include any break fees that may apply for terminating a fixed rate home loan before the end of the fixed term.
How important is the comparison rate?
Using the comparison rate as your basis for comparing various home loans from different lenders is a great start. It can show you the total cost of your home loan at a glance, without having to delve too deeply into the fine print to uncover any hidden fees or charges a bank might charge on top of the interest rate.
However, this shouldn’t be the only thing you consider when comparing your options. You also need to take into account the flexibility of the home loan type, along with any additional features of the loan that may suit your personal financial situation better. This might include linking an offset account to your mortgage or having access to a redraw facility, or the ability to make extra repayments without penalty.
You also want to compare rates accurately if you’ve chosen a fixed rate or a variable rate. This is because your loan will be locked into a fixed rate for a specified period of time, but will revert to whatever the variable rate is once this expires.
When you’re doing your research, be sure you are comparing the same loan types that include the same features. Then check the comparison rates for each of these to be sure you’re really comparing apples with apples.
When will you find comparison rates
Since 1 July 2003, banks and lenders are required by law to display the comparison rates wherever any advertisement for fixed term credit is shown. This includes home loans, personal loans and even credit cards. Essentially, any type of loan that can be used for personal purposes will have a comparison rate shown along with the interest rate charged for that loan.
How do you calculate the comparison rate?
If the comparison rate you’re given isn’t reflective of your loan amount or your preferred loan term, it is possible to calculate this yourself. The comparison rates are actually calculated using a formula that is governed by the Uniform Consumer Credit Code (UCCC).
The calculation is not simple, so you may find that using a good comparison rate calculator will make this easier for you. You simply plug in your home loan information and the calculator will create a comparison rate for you that is indicative of the true loan cost.
Before you begin, you will need the following information:
Loan amount
Loan term
Repayment frequency
Interest rate
Monthly account fee (if any)
Annual fee (if any)
Establishment fee (if any)
Valuation fee (if any)
Mortgage documentation fee (if any)
Settlement fee
When you have all this information, you’re able to enter it all into a good comparison rate calculator and reach a percentage rate that more accurately displays the real cost of a home loan.
Do the comparison rates calculate everything?
There are some fees and charges that shouldn’t be incorporated into your comparison rate calculations. These include:
Government stamp duty
Conveyancing fees
Late payment fees
Break costs or early termination fees
Deferred establishment fees
Redraw fees
Examples of Comparison Rates
Case Study 1
In this example, we’ll consider a lender advertising a really low rate of 5.7% for a home loan. Beneath this advertised figure in small print is the comparison rate 7.01%.
In order to reach this comparison rate figure, it’s important to factor in the fact that the 5.7% interest rate is only offered as an introductory variable rate that only lasts for the first 12 months of the loan. After this time, the interest rate reverts to the standard variable rate for the remainder of the loan term. For the purpose of this example, the standard variable rate is 7.15%.
This lender also charges a $500 establishment fee, along with a $185 valuation fee, a $100 settlement fee and a $250 security discharge fee.
When all of these fees, charges, interest rates and loan terms are combined, a borrower can then use the 7.01% comparison rate to determine the real cost of the loan. The advertised interest rate of 5.7% actually turns out to be far more expensive than it appears.
Case Study 2
In this example, we’ll look at a 5 year fixed rate home loan that is locked in at 7.19%. The comparison rate displayed next to this is 7.12%, which is actually lower than the advertised interest rate.
This most frequently occurs when the fixed interest rate is higher than the variable rate. Once the fixed term expires, the interest rate reverts to the standard variable rate. In this instance, the variable rate is 6.97%.
By the time you include the $500 establishment fee, as well as the $185 valuation fee, a $100 settlement fee and a $250 security discharge fee, the total comparison rate comes out to 7.12%.
Comparison Rate FAQ
Below are some answers to frequently asked questions about comparison rates:
What is the actual comparison rate?
The comparison rate is a calculation designed to help borrowers easily identify the true cost of a loan. This percentage rate includes the actual interest rate charged, plus any other fees or charges associated with the loan. The true costs are then converted into a percentage figure to make it easier for consumers to see at a glance how much that loan will really cost.
When will I be provided with a comparison rate?
Since 1 July 2003, comparison rates need to be provided in certain instances. These include:
Any advertisement for fixed term credit that displays an interest rate;
Any finance query through a financial institution, credit provider or finance broker for fixed term credit;
Any credit that is intended for personal or domestic use. Investment and business loans do not fall under this inclusion.
Fixed term loans are those that are calculated to be repaid over a specified period of time. For example: a 30 year home loan or a 5 year car loan. Credit cards do not have to be repaid within a particular time frame, so these are considered continuing credit and do not require a comparison rate.
How is the comparison rate calcualated?
The comparison rate is calculated using a formula governed by the Uniform Consumer Credit Code. The calculations take into account the following information to arrive at a comparison rate:
Loan amount
Loan term
Repayment frequency
Interest rate
Fees and charges associated with the loan
Fees that may not be included in the comparison rate calculation include:
Government stamp duty
Redraw fees
Break fees
Early repayment fees
Deferred establishment fees
Redraw fees
Top Tips
When you’re researching and comparing home loans in order to find the best deal for you, the comparison rate can be a great help in figuring out the true cost of the loan. However it shouldn’t be the only factor you consider.
It’s also important to make your home loan comparisons accurately according to loan type, flexibility, features and inclusions. This will help you narrow down the right loan types to suit your individual financial needs. From there, you’re able to compare similar loan types more accurately.
Here are some tips for finding the right home loan and comparing the options available:
1. Product Features
Always consider what type of home loan you want before you start looking at interest rates. Look at the inclusions and features of each loan and decide what you really want. You may choose to link a 100% offset account to your mortgage, or you may want the ability to redraw any additional funds you have available. You may also want the potential to take a repayment holiday at some point in the future. The features included in your loan should be a primary focus before you start comparing interest rates.
2. Flexibility
If you know you intend to make extra repayments off your mortgage, you need to narrow down home loan options that will allow you to do this. For example: some basic home loans limit repayment options to monthly repayments only in return for a super-cheap interest rate. If you want to pay fortnightly and you want to increase the payment amount you make, you might need to choose a different home loan.
Some fixed rate home loans also don’t offer a lot of flexibility in terms of making extra repayments. There are lenders that will impose penalties for paying too much extra during a fixed rate term.
3. Split Loan Facility
Many borrowers like the option of being able to split their loan between a variable portion and a fixed rate portion. This allows them the security of locking in some of their home loan at a fixed rate, while still taking advantage of the added flexibility of a variable rate loan.
4. Offset Account
If you’re searching for cheap interest rates alone, you may lose the option of linking a 100% offset account to your mortgage. If you’re the type of borrower who tends to leave money in savings, you can really benefit from offsetting the interest you pay on your mortgage this way. Many basic home loans won’t allow you to link an offset account.
5. Packaged Banking Products
You may want to streamline your banking so that your mortgage is linked to your savings account, your transaction account and your credit card. In some cases, the savings and transaction accounts can be merged into a convenient offset account. Packaging up your banking needs this way may make you eligible for certain discounts off your interest rate with some lenders that offer professional package home loans.
Once you’ve taken all these things into consideration, you can then narrow down your home loan options. Choose a few lenders with very similar products that include the features you want and then view the comparison rates for each of them. This will give you a clear idea of the cost of the exact type of loan you want that will suit your financial needs more accurately.
If you have any other questions about home loan comparison rates, leave a question and we'll be more than happy to help. If you want to start a comparison, jump back to the top of the page for a cross section of Australian home loans
The post Australian Home Loan Comparison Rates appeared first on Finder.com.au.