What is a comparison rate and how is it calculated?

What is a comparison rate and how is it calculated?
The comparison rate is one of the most important numbers to understand when you compare home loan rates because it helps to explain the true cost of a loan.
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A comparison rate is the true cost of a home loan. Using a formula it takes the interest payments, based on the advertised interest rate, and includes any additional fees and charges that come with the loan. The comparison rate is the interest rate, expressed as a percentage. However, it also includes any fees and charges that come with the loan.

This rate will be slightly higher given that it includes these extra costs, which you could otherwise overlook when working out how much you'll be paying back in the long run.

How is the comparison rate calculated? 

You may wonder how a home loan comparison rate is calculated. It uses a formula that considers interest payments plus any additional fees and charges. Obviously, the comparison rate will be a bit higher than the headline interest rate because it takes into account additional costs.

There are 3 main categories of fees that are typically used to calculate a comparison rate:

Upfront fees (application fees, valuation fees, legal fees etc.)

  • Application fee
  • Preapproval fee
  • Valuation fee
  • Documentation preparation fee
  • Legal fee
  • Settlement fee

Ongoing fees (monthly fees, package fees etc.)

  • Monthly account fee
  • Annual package fee
  • Periodical admin fee

Discharge fees for when the loan is finished

  • Discharge admin fee
  • Documentation preparation fee
  • Settlement fee

Comparison rates are uniformly calculated based on a loan amount of $150,000 with a loan term of 25 years, so it might not necessarily be 100% accurate since most mortgages are bigger than that now. Plus, a lot of home loans are now 30 years or longer. But the general idea is you can see how deceptively expensive a ‘low-rate’ loan might be.

It is important to keep in mind that the home loan with the lowest headline interest rate is not automatically the best deal that you can get. To illustrate: if one home loan offers an interest rate of 3.10 percent, with fees and charges totalling 0.10 percent per annum, the comparison rate will be 3.20 percent.

On the other hand, if the second home loan has an interest rate of 3.00 percent, with additional costs of 0.30 percent, the comparison rate is 3.30 percent. Even if the second home loan comes with a lower interest rate, its fees and charges pull the rate up, making it higher than the first home loan with a higher interest rate.

Why does the comparison rate matter?

The comparison rate matters because it can give you an idea of whether loan is good value for money or not, since it indicates whether a loan has any large fees that may not be immediately obvious.

By law the Australian government makes all lenders, banks and non-banks, advertise a comparison rate whenever we are advertising home loan rates.

It's a great thing that we have to do this because it gives you the ability to really compare different home loans across different companies equally. Credit providers set their own interest rates, and it's important to know exactly what you're getting when you approach them for a loan.

It may be hard to compare home loans with different interest rates and fees, so the lender has a responsibility to provide a comparison rate.

For example, home loan A might have an interest rate of 5.20 per cent and fees and charges of 0.1 per cent. Cumulatively, this means that the comparison rate is 5.30 per cent.

By contrast, home loan B might have an interest rate of 5.10 per cent and fees and charges of 0.4 per cent. That means the total comparison rate amounts to 5.50 per cent.

The important lesson here is that while home loan B has a lower interest rate than home loan A, its comparison rate is higher than that of home loan A - and this is what you will really be paying. So keep in mind that the 'lowest' price - the interest rate alone - is not always going to be the best deal for you.

For example, if a home loan provider has a standard variable rate listed and their comparison rate is a lot higher, this means you should look at any fees and charges on the loan.

If you've got a self managed super fund investment or you're paying a mortgage on your own home, then you'll know that the interest rate affects your loan.

The most common reasons that a comparison rate can be a lot higher than the actual rate the lender is advertising is because the loan has application fees or annual fees applicable.

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While the comparison rate isn’t the be-all-end-all, it is important, as even a marginal difference in the interest rate on your loan can cost tens of thousands of dollars overall,

To find a home loan with both a low advertised rate and a low comparison rate, check out some of our low rate home loans, or book an appointment with one of our friendly lending specialists.

Tags: compare home loans | comparison rate

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