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Home loan interest rates can be misleading. Do you know what different rates mean and how to choose the best option for you?

Advertised rate vs. comparison rate

Advertised rate

The advertised rate is one of the first things borrowers look at and is usually displayed prominently on home loan advertisements and loan listings on comparison websites. It is a useful starting point and gives you an idea of the range of headline rates that are available.

It is just the starting point though. You need to dig a bit deeper to find out the interest rate that actually applies to your home loan as well as what rate will work out more economical based on your loan amount when you add in any fees. It also does not give you any idea of the full cost over the life of the loan.

Comparison rate

The comparison rate was brought in through legislation. It is designed to give borrowers a better way to compare different loans from different lenders, due to the difficulty in comparing different home loans with different interest rates and different fee structures. It provides a standardised calculation of what the rate would be if you added in all the fees over the life of the loan.

What to be cautious about?

The main thing to keep in mind with the comparison rate is how it is calculated. It is based on a loan amount of $150,000 and a loan term of 25 years and is only correct for loans of that amount and that term.

How comparison rates are calculated

Basically all interest and fees charged over the life of the loan are added in to come up with the comparison rate. The following components are used in the calculation:

  • Interest Rate

    The headline interest rate for the home loan, used to calculate how much interest would be payable over the life of the loan.

  • Fees and Charges

    All the fees that are charged right up until the end of the loan are included to get a total cost over the life of the loan. For the comparison rate it is over 25 years so any annual or ongoing fees are going to influence the comparison rate more significantly than one off fees at the start or the end of the loan. Fees that you need to be aware of are:-

    • Upfront loan setup fees – application, valuation, lender legal fees, processing fees, title insurance etc
    • Ongoing fees – monthly or annual fees which could be called package fees or account keeping fees
    • At the end of the loan – discharge fee, legal fee etc
  • Loan Term

    Standardised term of 25 years.

  • Loan Amount

    Standardised loan amount of $150,000

What is not included?

So that the calculation is simple and focuses on the interest rate and the fees that can be easily ascertained it doesn’t include other fees and costs like:-

  • Lenders mortgage insurance
  • Stamp duty
  • Government registration and transfer fees

Although stamp duty and government registration and transfer fees will be the same regardless of which lender you choose, lenders mortgage insurance won’t be. It is lender specific and applies when you are borrowing above 80% of the value of the property. It is an insurance that protects the lender in case you default, which is passed onto the borrower and usually added to the loan amount.

As it can amount to thousands of dollars, if you are borrowing over 80% it is well worth getting lenders to give you a quote on how much it will be and use this in your comparison of different lenders.

To find out more about lenders mortgage insurance and how to avoid it click here.

Personalised comparison rate

Using this is probably one of the best ways to compare loans and work out which one is going to work out most economical for you over the life of the loan. It is virtually the same calculation as above but instead of using the standard 25 years and $150,000 loan amount, it does the calculation on your loan amount and your loan term.

This rate is not as convenient as the comparison rate and can’t be pre-calculated and shown for every loan you are looking at. You need to know where to find it as it is available for most loans from most lenders.

Where to get a personalised comparison rate

A personalised comparison rate can be found in a couple of places:-

  • Key Facts Sheet (KFS). It is one of the useful pieces of information that can be found in a KFS. A KFS generator can usually be found on a lenders website either in the calculators section or a link on a loan page. If the website has a search function you can try looking for it that way or Google the lenders name and then Key Facts Sheet to take you straight there.

    The first thing you do is fill in details of your scenario like the loan amount, loan term, interest type (variable or fixed) and select the lenders loan product. There is then a button that will generate a pdf with a whole range of information that can be used to compare different home loans based on your loan amount. These include the personalised comparison rate and total amount to be paid back over the life of the loan.

    Click here to generate a Key Facts Sheet on a State Custodians loan.

  • Home Loan Calculator. Some home loan calculators list the personalised comparison rate in the results section. It may be in a repayments calculator or a compare home loans calculator which will give you the personalised comparison rate for two different loans, side by side.

    Here are two calculators that include the personalised comparison rate:

Example

Let’s see how the two compare using the State Custodians Standard Variable and Breathe Easy Loans.

Scenario 1: Loan amount $180,000 for an owner occupied home valued at $350,000, over 20 years.

Loan Product Interest Rate Comparison Rate* Personalised Comparison Rate* Total amount to be paid back over the life of the loan
Standard Variable 3.74% 4.07% 4.04% $262,757
Breathe Easy 3.87% 3.90% 3.90% $259,708

At first glance, the Standard Variable has a cheaper interest rate but the comparison rate and personalised comparison rate both show that the Breathe Easy is cheaper. This is further confirmed when you look at the total amount to be paid back over the life of the loan with the Breathe Easy loan being cheaper by $3,049.

This is why it pays to get the complete picture. To do a rough interest only calculation to see if this is correct, there is a 0.13% difference in the rate, but the Standard Variable has an annual fee of $299 whereas the Breathe Easy has no ongoing fees. For a loan amount of $180,000 the difference in interest between the two rates for one year would be $234 interest saving on the lower rate Standard Variable loan. But once you deduct the annual fee of $299 it would make you worse off by $65.

Scenario 2: Loan amount $580,000 for an owner occupied home valued at $800,000, over 30 years.

Loan Product Interest Rate Comparison Rate* Personalised Comparison Rate* Total amount to be paid back over the life of the loan
Standard Variable 3.74% 4.07% 3.82% $975,646
Breathe Easy 3.87% 3.90% 3.88% $985,134

Once again the Standard Variable has a cheaper interest rate but the Breathe Easy has the lower comparison rate. The personalised comparison rate has the Standard Variable as the cheaper option and this is confirmed when you look at the total amount to be paid back over the life of the loan with the Standard Variable loan being cheaper by $6,488.

To do a rough interest only calculation to see if this is correct, there is a 0.13% difference in the rate, but the Standard Variable has an annual fee of $299 whereas the Breathe Easy has no ongoing fees. For a loan amount of $580,000 the difference in interest between the two rates for one year would be $754 interest saving on the lower rate Standard Variable loan. Even once you deduct the annual fee of $299 you are still better off by $455 per year.

Is the annual fee worth it?

Often loans with annual fees come with a cheaper rate and a range of additional features and benefits which can make it worthwhile paying the annual fee. What a borrower needs to determine is :-

  • Do you need an offset account? One of the most sought after features for home loans is an offset account. Offset accounts can be a necessity for tax purposes but for most of us they are a luxury because you can achieve similar savings to an offset account by paying extra into the loan and redrawing for free.

    To find out more about free redraw and offset accounts read our blog here.

    If it is an investment loan check out some hints here.

  • Calculate a value for each of the benefits that come with the annual or ongoing fee. This could be the amount you save in interest by having an offset account. Click on the Options to save in the repayments and savings calculator and put in your average offset account balance. For free valuations, work out how often you would do this and give it a value of a few hundred dollars. If it is no annual fee on your credit card, find out what the annual fee is.

What to be cautious about?

Both the comparison rate and personalised comparison rate focus entirely on the interest rate and fees. There are lots of other things to consider when you are looking for the right home loan to suit your circumstances. These could include:-

  • Features that help you save money like an offset account or being able to pay extra and redraw for free or
  • A particular type of loan that you need like an interest only loan or line of credit or
  • The reputation of the lender or their level of customer service which can impact your lending experience

Quick Tip

These calculations are done using the full term of the loan whereas in reality it is unlikely that you will have the same loan for the full term of 20 or 30 years. If you think that you might keep the same loan for 5 or 7 years do calculations based on this. It can often work out that interest savings of switching to a marginally lower interest rate, can be overshadowed by discharge and setup fees. It may take a number of years to be better off on the new loan.

To find out more about how to work out whether it is worthwhile switching loans read our blog here.

Introductory rates

An introductory rate loan is where the interest rate is significantly lower for the first few years of the home loan, but then reverts back to a higher interest rate thereafter. The advertised introductory rate can be very attractive and some borrowers may find it useful.

For example, it can give first home buyers a chance to ease into lower repayments for the first few years of the loan or give other borrowers an opportunity to repay extra on their home loan during this period.

Tell tale signs

While a loan may not necessarily state that it is an introductory rate home loan, there are certain tell tale signs that tell you that it is. It may be:-

  • In the name of the loan. ie. 3 year special variable rate
  • The fact that it is significantly below the cheapest loans on the market sometime by up to 0.25%. In this case the old adage applies, if it seems too good to be true, it probably is
  • The comparison rate is a lot higher compared to similar loans. If the comparison rate is significantly higher than the advertised rate by anywhere from 0.30 – 0.60% then it is probably indicating that it is more than just fees that are pushing it higher. A jump in interest rate after a certain amount of time will significantly increase the comparison rate

Dig a little deeper

Once you have spotted something that you think may be an introductory rate loan, you need to investigate further.

  • Read any disclaimers or fine print alongside where it is advertised
  • Click through on the ad to the product page and see what disclaimers and fine print there is at the bottom of the product page
  • Go to the product page on the lenders website and read the details. Keep an eye out for a revert interest rate or an indication that the headline rate is limited to one or two years
  • Call the lender and ask if it is the ongoing rate and get the details around what it reverts to

What to look out for

While there are certain benefits to this type of rate, there are certain precautions you should take.

  • Pay attention to the revert rate as this can often be less competitive compared to other rates on the market. So even though you will pay less in interest the first couple of years, you may end up paying more in the long run or have to refinance in order to save
  • Be sure you can afford the higher repayments because once the rate reverts back, you could get into financial strife
  • See what features are available as some lenders may limit the number of features
  • Don’t forget about fees. Introductory rates can come with higher upfront and ongoing fees, which can outweigh the benefit of a lower rate

Fixed rates

An attractive fixed rate can be used to lure borrowers similar to an introductory rate so it pays to do thorough research. Once again comparison and personalised comparison rates can come in handy as they will help in comparing different offers. Both these comparison rate calculations factor in the revert rate at the end of the fixed period so by focusing on this you may find that a slightly higher fixed rate may end up being better in the long term due to it reverting to a better variable rate home loan. Having to refinance at the end of the fixed term can work out costly so negotiating a good variable rate at the end can save you thousands in discharge and setup fees if you don’t have to refinance.

A fixed rate is most useful for those who are on a tight budget and need to know exactly how much their repayments will be over a term of 1 – 5 years. Not only can it help borrowers budget, but if you fix your rate at the right time, you may save significantly on interest during the fixed period. This will all depend on what happens to variable rates.

What to look out for

  • What are your plans for the next five years? Do you want the flexibility to be able to sell the property or refinance your loan if the opportunity arises. Due to fixed rate break costs, if the variable rate falls below the fixed rate, then these costs could amount to thousands of dollars and effectively lock you in
  • Do you want access to extra features? You may not have access to as many features such as an offset account, redraw and extra repayments with a fixed rate loan. Being able to pay extra can be important to cut years off the term of your loan so if you are unable to do this, is it worth the interest saving you get on the fixed rate
  • What is the revert rate? Similar to the introductory rate, if the rate you revert to after the fixed period is not competitive, it could defeat the purpose of locking in a low fixed rate

To find more about fixed v’s variable rate, check out our blog here.

Interest only

Interest only home loans can be beneficial for a range of different borrowers. As the name suggests, borrowers only have to pay interest plus any fees for a certain number of years (usually five to 10 years). Then once the interest only period is over, borrowers revert back to a principal and interest loan where they start repaying the amount owing. Comparison rates are not useful for interest only loans as they are based on principal and interest repayments.

What to look out for

  • Can you afford the principal and interest repayments? After the interest only period expires, the loan will revert to principal and interest repayments for the remaining term. This can be a significant jump in repayments. You could refinance or negotiate a further interest only period but if you weren’t in the position to do this the higher principal and interest repayments could cause you financial stress.
  • If you just pay the minimum you will never reduce the amount owing. This can result in paying more interest over the life of the loan. It also means that when you sell the property you are relying on the value of the property increasing to make a gain.

To find out more about interest only home loans, click here.

How to get the interest rate that applies to your loan

Lenders determine interest rates based on a number of factors. The advertised interest rates often are “from x%” indicating that for different scenarios the rate may be different.

These could be :-

  • Loan amount

    Some rates are only available if you loan is above a certain minimum.

  • Loan to Value Ratio (LVR)

    The amount you borrow compared to the value of the property will be a contributing factor to your interest rate. Lenders will usually charge a higher interest rate to those that borrow over 80% as these loans are considered more risky. Conversely if you are borrowing less than 80% then you can expect more competitive interest rates.

  • Property use

    Are you going to use this property as an owner occupier or an investment? Recent changes to investment lending requirements mean that some lenders have changed their investment loan guidelines and could affect the amount you are able to borrow and the interest rate.

  • Purpose of the funds

    Similar to the above, some lenders apply a higher interest rate if the funds are being used for investment.

  • Principal and interest or Interest only repayments

    Also similar to the above, some lenders apply a higher interest rate for interest only loans as these are most often investment loans.

  • Credit rating

    Your credit history can also affect the interest rate. If you have defaults, missed repayments and/or multiple credit enquiries, lenders may reduce the LVR, increase the interest rate in order to protect themselves if you default or simply decline the application altogether.

    To find out more about how you credit rating affects your home loan application click here.

  • Location of property

    If the location or the property is considered high risk by a lender, borrowers may be faced with a higher interest rate.

    Find out more about how location affects lending here.

To find out more about what impacts the variable interest rate you can get click here

Quick Tip

Before you go headlong into your comparison it may be worth contacting the lender who has a loan you are interested to ensure that you qualify and what interest rate applies to you. It is no use doing all the comparisons on paper only to find that due to whatever reason the interest rate or loan you were interested in doesn’t apply to you. You should be able to run through your scenario quickly over the phone. They can then advise on the fees, benefits and features of the loan.

Choosing the right interest rate to suit you is an important decision and the team at State Custodians can help. Our Lending Specialists can give you the information you need to make an informed decision, whether it be for a fixed, variable or split home loan.

You can call them on 13 72 62 or leave your details here and they will contact you.

Find out more about other home loan options and get tips on what to look for: