What is a comparison rate?
If you’re asking yourself ‘what is a comparison rate?’ then you’ve come to the right place. Understanding comparison rates is important if you are taking out a mortgage for a home. Ultimately, a comparison rate aims to explain the true cost of a loan.
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.
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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