In this article:
Introduction
When it comes to navigating the complex world of home loans, there are numerous factors to consider. Among the most critical, yet often misunderstood, is the Comparison Rate. This rate reflects the true cost of your home loan when you consider all fees and extra costs, over the life of the loan.
All lenders are required by law to display the comparison rate near the headline interest rate. It aims to provide a more accurate overview of the cost of a home loan, by including the interest rate and any ascertainable fees or charges associated with the loan. In essence, the comparison rate allows you to see the ‘real’ cost of your loan over its full term, factoring in initial discount rates and fees.
Understanding this rate is pivotal in making an informed decision about which mortgage product best fits your financial circumstances and goals. Many borrowers aren’t aware of how it impacts borrowers, and what to consider when comparing home loan products.
The Concept of Comparison Rates
Comparison rates were introduced by the Federal Government as a way to standardise and simplify how lenders presented home loan costs to consumers.
The idea was to make it easier for borrowers to compare loans from different providers, ensuring transparency and fairness within the home loan market.
How it Works
The comparison rate calculation is based on an industry-wide set of criteria, which all lenders must adhere to. It takes into account the interest rate, ongoing and upfront fees, as well as any other costs that are linked to the loan. It’s important to note that not all fees, such as government charges or fees for optional services like offset accounts, are included in the calculation.
Use our comparison rate calculator.
While the comparison rate is a useful tool to understand the overall cost of a home loan, it is not without its limitations. The primary issue is that the comparison rate does not consider the individual borrower’s circumstances. It doesn’t account for the features and benefits that may be important to individual borrowers, like the flexibility of loan terms or the availability of offset accounts.
Moreover, the comparison rate is calculated on a standard loan amount and term from years ago, usually a $150,000 loan over 25 years, which may not reflect the actual loan requirements of many borrowers. As a result, a loan that appears cheaper based on the comparison rate may not necessarily be the best fit for a borrower’s specific needs or financial situation.
The comparison rate also excludes government charges and optional service fees. This means that while the comparison rate can help you to compare the ‘base cost’ of different loan products, it may not give you a complete picture of all the costs you may incur over the life of the loan.
Therefore, while the comparison rate is a useful starting point, it’s essential to consider other factors and seek professional advice when comparing home loan products.
Why it Matters
The answer lies in its ability to help you make an informed decision about your home loan. By having access to this information, you can compare loans from various providers on a level playing field, taking into consideration all associated costs.
This allows you to better understand the true cost of your home loan and make a more accurate comparison between different products, particularly when you’re reacting to online advertisements from lenders, or doing an initial review of current loan offers.
The home loan market is very large and very competitive in Australia. In order to compete, lenders use headline interest rates as a marketing tactic to attract customers, often offering discounted introductory rates or waiving establishment fees. While these may seem like great deals, it’s important to remember to assess the comparison rate to gauge whether a deal looks too good to be true, at least initially.
Often lenders will use several tactics to lure in borrowers through their advertising. A “discount rate” is offered as a subtle discount off the standard variable rate being offered by that particular lender for a short period of time, usually enough to at least get your attention and start a conversation with the lender about their loan products. An “introductory rate” is very similar – it is a low-interest rate offered for a period of between 1 – 3 years, which then reverts to a higher than the market average rate when the introductory period ends. Again, both offers are designed to entice borrowers into particular loan products.
How to Use Comparison Rates When Choosing a Home Loan
Mark Bouris fought for the introduction of legislative changes in the early 2000s to bring greater transparency in the home loan market and successfully campaigned for the comparison rate requirement.
“Two loans with the same interest rate can have quite a drastic difference between the overall cost in the long term,” said Bouris.
“If you are looking at a home loan and comparing just interest rates, you can be sucked into thinking that two loans cost the same, when in fact they’re a long way apart over the length of your loan. All lenders are legally obligated to display the comparison rate, as it’s closest to the ‘true’ rate you will pay after all is said and done. This is something I fought to have legislated for back in the late 90s, to help simplify everything for consumers.”
“What I’m worried about is consumers getting locked into fixed rates or loan deals because of an extremely low-interest rate, when it could bite you down the track.”
When comparing home loans, it’s essential to look beyond the headline interest rate and consider the comparison rate as well. This will give you a more comprehensive understanding of the total cost of your loan over its full term. Keep in mind that a lower interest rate may not always result in a lower comparison rate if there are high fees associated with the loan.
Additionally, it’s important to consider your own financial situation and goals when choosing a home loan. The comparison rate can help you evaluate the long-term affordability of a loan, allowing you to make an informed decision that aligns with your needs.
Despite the advantages of using comparison rates, employing the services of a mortgage broker can take your home loan search to the next level. Mortgage brokers bring a wealth of knowledge and expertise to the table, making them invaluable allies in navigating the complexities of the home loan market. They have access to a wide range of loan products from various lenders, some of which may not be readily available to the general public. A broker can assess your personal financial situation, and align it with the best suitable loan product, taking into account not only the comparison rate but also the loan features and flexibility that would best suit your needs.
