Home Loan Comparison Rates Explained
What Is A Comparison Rate?
If you have been looking for a loan, you will probably have noticed that next to each interest rate figure advertised, there is a separate 'comparison rate' figure. Some people think that the comparison rate is the average of all the other banks interest rates. THIS IS NOT TRUE. The comparison rate is the true cost of the loan which is being advertised. It takes into account the fees and other charges that you will have to pay in addition to interest repayments for the life of the loan. It adds this amount of fees and charges on top of the interest amount you will end up paying, combining these two amounts to give you a real total cost of paying off the loan, calculated into a single percentage.
What Is The Point Of A Comparison Rate?
It makes it easier for a consumer to see what the loan will really cost, and thus makes it easier to compare loans across different lenders without having to go through all the fine-print relating to fees for this and charges for that. It is rare for the advertised interest rate to be identical to the comparison rate, it is therefore a good idea to put more emphasis on comparing comparison rates amongst banks, when compared to simply the interest rate.
Example Of How A Comparison Rate Works
Say Bank A is offering an interest rate on their home loan of 6.97%, while their comparison rate is 7.31%, Bank A only charges one annual fee of $395. If you were to take out a loan of $150,000, over 25 years, the following would happen...
- The total interest you'd pay on the loan would be $167,190. (This is the 6.97% interest rate figure)
- The total amount of fees you would pay on this particular loan over 25 years is $9,875.
- When you add these two amounts together you get $177,065 (This is the 7.31%)
When The Comparison Rate Doesn't Work
The example above showed what would happen if you took out a loan for $150,000 over 25 years. Comparison rates apply only for the specific set of circumstances specified. If you are taking out a loan which differs to these circumstances, the comparison rate will change. For example:
If you were to take out the same loan with Bank A, but this time for $500,000 over 30 years, the following would happen...
- The total interest would be $693,918 (Thats the 6.97% interest rate figure)
- The total fees over 30 years would be $11,850
- When you add these two amounts together you get $705,768
- In this example, the comparison rate would be 7.07%
As you can see, the advertised 7.31% comparison rate does not apply here as the actual rate of interest plus fees would equal 7.07%. There are also some fees which may not be included in a comparison rate, such as government fees, or fees that are only charged in certain circumstances, such as 'Early Repayment fees'. You can find out more about comparison rates from MoneySmart.
This is why it takes more than simply looking at one figure to decide on which home loan you will take out. Although the comparison rate is a useful tool, it should just be one of the tools you use. For personalised advise regarding loans, talk to a qualified financial advisor, who will be able to assess your situation and suggest products to work for you.
If you want to do your own research, you can compare a selection of home loan rates and comparison rates on our Home Loan Comparison Page.