Australian lenders are legally required to indicate a loan’s comparison rate – that is, the total cost of a loan. This information means you can accurately compare different loans over a set period.
But what is a comparison rate? And how is a comparison rate calculated? Understanding these points will assist you in making a more informed decision on the best home loan to suit your budget.
In this article, we explore everything involved in calculating the true cost of a home loan.
Home Loan Interest Rate vs
Comparison Rate
An interest rate is relative to the cash rate and determines how much interest will be charged on your home loan balance per year, directly affecting your monthly repayments.
The comparison rate combines the interest rate with all the fees and charges attached to the loan. Therefore, comparison rates help you determine a more accurate loan cost, making it easier to compare different loan products.
By considering interest rates in isolation, two home loans can seemingly cost the same, but using the home loan comparison rate will reveal the difference in costs between the two.
For example:
Three home loans have an interest rate of 3.04%, but they have varying fees and charges:
Loan 1 | Loan 2 | Loan 3 | |
Upfront fees | $0 | $600 | $0 |
Annual fees | $0 | $300 | $300 |
Discharge fees | $0 | $0 | $350 |
Total fees paid over loan’s 30-year lifespan | $0 | $900 | $10,800 |
Comparison rates | 3.04% | 3.09% | 3.42% |
As seen with this example, just because three loans have the same interest rate doesn’t mean the total amount paid over the loan term will be the same.
How Lenders Calculate the Comparison Rate
Lenders calculate loan comparison rates using a specific formula. The calculation requires the following information to be taken into account as they affect the overall cost of the loan.
Interest rate
Comparison rates are calculated based on the actual interest rate charged by the bank for your home loan.
Fees and charges
Most lenders charge borrowers a monthly account fee or an annual fee. Other once off charges can include:
- Establishment fee
- Mortgage documentation fee
- Valuation fee
- Settlement fee
Loan amount
Take note that some banks will offer perks in the form of cost savings. These include discounted interest rates on more significant loan amounts, meaning that the rate could end up being lower, despite the bigger loan amount.
Loan term
The longer a loan term, the higher the comparison rate. Lenders typically calculate comparison rates over a 25-year period; if yours is a 30-year term, you can have the comparison rate reworked for an accurate reflection.
Payment frequency
Your mortgage’s interest is calculated daily based on the remaining outstanding balance. Therefore, making more frequent repayments will reduce the balance quicker, which reduces the overall comparison rate.
What isn’t included when calculating the comparison rate
Some costs can affect how much your loan costs overall but cannot be included in the comparison rate calculations, such as:
- Stamp duty
- Late payment fees
- Early repayment fees
- Conveyancing fees
- Break costs or early termination fees
- Redraw fees
- Deferred establishment fees
Where to Find the Comparison Rate
Home loan comparison rates will state: “Variable interest rate X, comparison rate Y, based on a 25-year loan of $150,000.” There must also be a warning about the comparison rate’s accuracy.
Also included on the key facts sheet are the interest rate, comparison rate, and the total amount due over the life of the loan.
Take note that personal loans and car loans also have comparison rates, but they depend on different loan amounts and loan terms.
Do Comparison Rates Indicate the True Cost of a Home Loan?
While calculating comparison rates is a more accurate depiction of the total cost of a home loan, generally it is misrepresented by the value of the loan advertised with comparison rates. This is because the loan amount used is $150,000, which isn’t 100% accurate as a majority of the consumers loans is above $150,000.
Firstly, as mentioned above, a few factors, such as fees and charges, aren’t included when lenders calculate the comparison rate.
Secondly, they calculate the rate on a secured loan of $150,000 over a 25-year term. Many home loans exceed $150,000 and are paid off over 30 years or more.
- Variable interest-only loans: rates based on a 5-year interest-only period.
- Fixed interest-only loans: rates based on an interest-only period equivalent to the fixed period.
When considering the comparison rate, consider these factors to determine whether it’s a true reflection of the actual cost of your loan. It can be useful to generate your own comparison rate for your expected borrowing amount.
Therefore, you should be somewhat weary of the advertised comparison rate. It can be a helpful and more accurate tool when you’re comparing home loans, but be sure to ask questions and not accept things at face value. You don’t want to end up paying thousands of dollars more because of additional fees they didn’t include.
Find the Best Home Loan for Your Financial Situation
If you’re looking at a particular product offered by multiple lenders and are unsure whether the comparison rate is an accurate representation, consider contacting a mortgage broker to help.
Mortgage brokers have the expertise to differentiate between the advertised interest rate, and comparison rate, and determine any other ongoing costs or additional fees.
This way, they can consider your personal objectives and circumstances and indicate which loans can save you money—and why.
Key Takeaways
Checking the comparison rate of loans from different lenders can give you a more accurate idea of the overall annual costs. This can assist you in choosing the best possible loan for your situation, and potentially save you thousands of dollars in fees over the years.
Although the rate is readily available for all borrowers to view, it sometimes excludes various fees that can impact the total cost.
Therefore, it can be beneficial to work through a mortgage broker who can ask all the right questions on your behalf.
The Mortgage Agency has licenced professionals that can help you achieve your homeownership goals. Contact us today to get started.
Disclaimer:
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.
