A comparison rate is often an overlooked factor when comparing home loans. See how you can use it to find a better home loan.
The idea behind comparison rates was to help borrowers understand how any fees or charges would impact an interest rate.
It can help borrowers compare loans from different lenders by revealing the true cost of a loan. Comparison rates are a handy tool but you need to understand how to use it and its limitations.
The comparison rate is a standardized calculation of the interest rate plus any fees and charges added in. This gives borrowers an initial idea about what the loan will cost them without having to look at the fine print.
The comparison rate was introduced as a way to keep lenders honest and accountable about the true cost of their home loans. It also stops lenders from drawing borrowers in with extremely low interest rates, but then slamming them with large fees without them knowing.
Did You Know?
Ever wondered what the second interest rate was next to the advertised interest rate? That is the comparison rate. Lenders are legally required to provide both interest rates when advertising.
The comparison rate can tell you a lot about a home loan.
Are the interest rate and comparison rate the same? If the comparison rate is the same, or close, to the interest rate, that means the lenders has no setup, ongoing and discharge fees.
Is the comparison rate higher? This means that fees and charges apply to this loan. A small increase may mean there are only upfront fees, however a significant jump in rates could mean there are also ongoing fees.
Is the comparison rate lower?Some lenders offer benefits to their borrowers which can actually reduce the interest rate over time. This will result in a comparison rate being lower than the interest rate.
At a quick glance, by comparing the interest rate and the comparison rate you can tell certain things about the loan. Below is a table with a number of different current loans.
|Home loan||Interest Rate||Comparison Rate*||Fees||Revert rate|
|1. Variable rate||3.74%||3.74%||$0||-|
|2. Variable rate||3.89%||3.91%||$220 valuation
|3. Variable rate||3.63%||4.03%||$375 annual fee||-|
|4. 3 year fixed||3.99%||4.64%||$600 establishment fee||4.81%|
|5. 3 year fixed||3.99%||4.94%||$395pa ongoing||4.57%|
|6. 3 year fixed||3.99%||3.93%||No establishment or ongoing fees, $300 settlement fee, $550 discharge fee, $200 valuation||3.89%|
|7. 3 year fixed||3.74%||4.88%||$600 establishment fee, $350 settlement fee||5.21%|
|8. Introductory rate (6 months)||3.52%||4. 14%||$10 monthly fee, $200 settlement fee, $450 discharge fee||4.02%|
What can we learn from this table?
Loan one: A home loan with the same interest and comparison rate means there are no setup, ongoing and discharge fees. In the current market this would be a really competitive offering but could have restrictions like only being able to lend up to 80% of the value of the property, having the purpose as owner occupied and possibly no offset account and restrictions around redraw. It may also not allow for increases down the track or self employed.
Loan two: This home loans has a slightly higher comparison rate, which usually means there are possibly some setup fees as well as discharge fees. It would be highly unlikely that it could have any ongoing monthly or annual fees. Restrictions may include only lending up to 80% of the value of the property and owner occupied purpose only. May have an offset account and come with a good range of features.
Loan three: While the interest rate is lower than the other variable rate loans, this product has an annual fee of $375, which makes the comparison rate significantly higher. This is a great example of how the comparison rate gives a true picture of how much the loan will really cost you.
Loan four & five: If the comparison rate is significantly higher than the interest rate, then you will need to look out for upfront fees as well as ongoing fees. Fixed rate home loans often have higher comparison rates as the fixed rate is usually well below the rate it reverts to.
Loan six: As this loan does not have any establishment or ongoing fees, the comparison rate is lower. However, there may be certain restrictions such as a minimum loan amount of $500,000, but may still allow some additional repayments.
Loan seven: This is a great example of why it is some important to check the revert rate at the end of the fixed period. This loan jumps from 3.74% fixed to 5.21% after the fixed term. It is vital to have a good understanding upfront of how much the loan is going to cost you for the whole loan term, not just the first few years.
While fixed rates may have competitive interest rates initially, there are a number of restrictions that apply. Some of these may include less features and fees if you try to repay extra. Find out more about fixed home loans here
Click here to find out more about fixed rate home loans.
Which fixed rate is most economical?
Taking a look at the four fixed rates above, if you have a loan amount of $150,000 over 25 years, it would be most economical to go with loan six.
There are no establishment or ongoing fees, which helps keep the comparison rate low, plus the revert rate is much more competitive.
Loan eight: Lenders often offer introductory rate home loans to help draw in borrowers. They offer competitively low interest rates for the first 6 months to a year, but then this reverts back to a standard variable rate. It may also come with restrictions to qualify like, having to have 30% equity and it may only allow principal and interest repayments on an owner occupied home. Positives and negatives include:
Reduced repayments initially may help first home buyers get used to mortgage repayments
Borrowers can use this time to pay extra off their home loan
Can come with higher setup and ongoing fees
The variable interest may not be the most competitive in the market after the honeymoon period
Borrowers may struggle to meet higher repayments when the interest rate reverts back
Home loan features may be restricted
But how do you spot an introductory rate? When home loan shopping, keep an eye out for the product with significantly lower interest rates compared to other similar products on the market, particularly if it is a variable rate. The lender may also indicate in the heading that this is a ‘special’ or ‘limited time’ offer or have a time period included in the name of the loan ie. discounted variable 6 months.
Take a look at the first two variable loans – while the introductory rate is lower than both, you will see that both the comparison rate and revert rate are significantly higher.
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
While the comparison rate is supposed to give you a more accurate idea about how much your loan will cost you, there are a few costs that are not included:
- Government charges such as stamp duty or mortgage registration fees
- Fees and charges for certain features that may or may not be used by the borrower, such as redraw facilities and early repayments
- Lenders mortgage insurance if you are borrowing more than 80% of the value of the property
- Default charges if you have a missed or late repayment or if you break a fixed loan
- Cost savings such as fee waivers which the lender may offer
Did You Know?
Lenders mortgage insurance is lender specific so varies depending on the lender. If you are borrowing more than 80% of the value of the property it may pay to shop around and get quotes on mortgage insurance. It is an insurance passed onto you by the lender and protects them in case you default which is passed onto the borrower. It can amount to thousands of dollars.
To find out more about Lenders Mortgage Insurance Click Here.
While the advertised comparison rate can give you a starting point for comparing different home loans, it is only accurate for the scenario it is based on ie a loan amount of $150,000 and loan term of 25 years. A different loan amount and term will result in a different comparison rate. You may get the opposite result and an indication that another loan may be more economical for your loan amount and loan term.
This is where a personalised comparison rate comes in handy. It does a similar calculation but allows you to tailor it to your loan term and loan amount. You can then use this in your comparison of different loans.
There are a number of ways to calculate the specific comparison rate that will apply to your situation:
Home loan calculators
Online calculators are quick and easy to use and can give you answers straight away. Some repayments and home loan comparison calculators give you a personalised comparison rate in the results. This way you can enter the details of any loan and get the personalised comparison rate on the spot.
Do it yourself
Take a look at our calculators below which give you a personalised comparison rate:
The Key Facts Sheet
Just search the lenders name and Key Facts Sheet and it should take you straight there. Alternatively look in the calculators section of lender websites to find them for the specific loan you are looking at. 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.
What is a Key Facts Sheet?
Key Fact Sheets were introduced by the Australian Government as a part of the banking reforms. All lenders who offer standard home loans are required to make Home Loan Key Fact Sheets available on request. They provide a standardised layout of information so that you can compare and select the most appropriate home loan for you.. The Key Facts Sheet will give you a personalised comparison rate which includes the ongoing fees and interest rate for your specific loan amount.
For a Key Facts Sheet for a State Custodians loan Click Here
Have a lender do the calculations
Lenders do these types of calculations every day. If you find the process a little overwhelming. Ask the lender to generate a personalised comparison rate for you.
While the interest rate and comparison rate can give you an idea about what you might spend on a home loan, there are lots of other things to consider when you are looking for the right home loan to suit your circumstances. These may 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
Our friendly Lending Specialist team has the expertise and experience to help you with your calculation. Give them a call 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: