Are you a first-home buyer? If you’re looking to purchase a home and are new to the world of mortgages, understanding interest rates can be confusing. Variable interest rates, fixed rates and comparison rates - what does it all mean? Well, you've come to the right place.
A comparison rate represents the true cost of a loan and aims to show that as a simple-to-understand number in the form of a comparable interest rate. All lenders must show a comparison rate alongside their advertised interest rate by law.
Home loan interest rates and fees vary, so it’s important to understand the true cost of your loan and know how much your monthly repayments will be.
This article will explain more about the comparison rate, how it is calculated, what things are and aren’t covered, and why it matters when choosing your next home loan.
What is a Home loan comparison rate?
A comparison rate looks at the overall try cost of your home loan. Unlike a standard variable rate home loan or fixed rate that is often spoken about, the comparison rate uses a formula to account for interest payments based on the advertised rate but also includes different fees and charges that you may come across in your loan term.
A comparison rate is an interest rate, typically expressed as a percentage rate. It also includes any other fees on the loan, like monthly account-keeping fees. The rate will usually be higher than the standard or fixed rate because it considers the hidden costs that you may overlook when speaking to a lender or mortgage broker. Your lender may also have a repayment calculator online that can help you understand your principal & interest repayments and your current borrowing power.
This can be a more holistic and accurate way of working out how much you will repay your financial institution in the long run.
What does the comparison rate include?
The comparison rate is calculated using a formula that looks at the interest rate and other fees and charges. Due to this, the comparison rate typically will be higher than the advertised headline rate because it considers the additional costs.
When a comparison rate is the same as the advertised interest rate, that means that the loan has no associated fees. That said, you should always check the conditions of your specific loan.
The comparison rate is calculated using the interest rate and other charges. Considerations include:
- the amount of the loan
- fees and charges
- loan term (typically 25-30 years)
- mortgage repayment frequency and type (principal and interest or interest only repayments)
- interest rate (variable rate or fixed rate home loan)
Three categories are generally considered when calculating the comparison rate. This can differ between different lenders, so some fees may not apply:
Any upfront fees (valuation fees, application fees, legal costs)
- Application fee
- Preapproval fee
- Valuation fee
- Documentation preparation charges
- Legal fee
- Settlement charges
Ongoing fees (monthly costs or package costs)
- Monthly account-keeping fee
- Annual fees for the loan or package
- Periodical admin fee
Discharge fees upon loan completion
- Discharge fee
- Documentation preparation charges
- Settlement charges
Comparison rates are all calculated off a uniform loan amount of $150,000 and a loan term of 25 years, which might not be 100% accurate since most mortgages are larger than this, and loans can go for 30 years +.
The general need for the comparison rate is to ensure that deceptively low rates aren’t being offset with giant fees and negatively impacting you in the long run.
What does the comparison rate not include?
The comparison rate doesn’t include all fees and charges that you will encounter in the home-buying process. Things not included are:
- Any optional items included in or added onto the loan. Some loan options that are not included are early repayment fees or redraw fees, a redraw facility, and offset accounts.
- Any lenders mortgage insurance (LMI) charges.
- Any government charges, including mortgage fees, stamp duty or land title costs.
- Any fees and charges that aren’t available at the time when the comparison rate is calculated and provided.
- Any cost-saving waivers or offsets that can influence the cost of a loan. Including cashback offers.
- Any extras the lenders may add, like fee-free credit cards, transaction accounts or discounts on personal loans.
Why pay attention to comparison rates?
The comparison rate can show the real cost of a home loan. This can be useful, as often, the loan with the lowest interest rate may not actually be the most affordable option.
Looking at the interest rate alone, you may not be privy to additional fees associated with the product. So, considering the comparison rate helps you understand the true cost of the loan and decide what is best for your budget and long-term financial future.
Lenders and loan providers usually offer various different home loan types with a range of interest rates. All rate types, variable rates and fixed rates, are advertised with accompanying different comparison rates.
Which home loan products you qualify for depends on if you’re an owner-occupier or investor, as well as your property type, property value and financial situation - such as credit score and deposit amount saved. For example, low-interest rate loans often require a low loan-to-value ratio (LVR). If your LVR exceeds 80%, meaning you have a deposit of less than 20% of your home’s value, you will likely face a higher interest rate.
So, when you go to enquire about your home loan options, checking the comparison rate is a critical step, especially if you’re not in a strong financial position and the interest rate seems too good to be true. It’s also critical to remember that variable interest rates shift with the cash rate, so a comparison rate cannot predict where your interest rate will be in the future. Even with a fixed-rate loan, once the fixed term (or fixed rate period) is finished, it will revert to the current variable rate or your lender’s basic home loan - which the comparison rate also does not account for.
Comparison rates are not only important when you’re looking for a new home. Refinancing is another great time to monitor a loan’s comparison rate. When you refinance, you’re often looking for a better interest rate based on the increased equity you have accumulated since the beginning of your existing home loan. You can look at the new loan’s comparison rate to ensure you save money on your home loan repayments.