What is a comparison rate?
A comparison rate can help you work out the true cost of your mortgage, but they're not always helpful. Let's dig deeper into how comparison rates work and how you can calculate your own comparison rate.
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A comparison rate is a rate that all lenders by law must display next to their advertised interest rates. It's a rate that takes into account some of the fees and charges of a home loan, and it's designed to give you a more accurate representation of a loan's true cost once all of the fees, charges and costs are taken into account.
Comparison rates were made mandatory in an attempt to stop lenders from advertising very low interest rates that lured unsuspecting borrowers into loans that actually cost them far more in the long run. For instance, a lender might have advertised a low mortgage interest rate of 2.5%, but then charged $20 per month in account keeping fees and an annual $400 loan package fee. Once these expenses are added in, the loan could be more expensive than a different bank that was charging 2.6%, but with no fees.
A comparison rate on a home loan is legally mandated to be calculated based on:
- An example loan of $150,000
- A loan period of 25 years
- A principal and interest loan
Back when comparison rates were introduced in July 2003, these figures made much more sense. Today, the average loan size is much more than $150,000: the latest stats put the current average loan size closer to $500,000.
The average loan term for the majority of borrowers is also 30 years, not 25 years.
It's important to be aware of this when looking at the comparison rate, because if your loan is more than $150,000, the comparison rate won't be a true reflection of the actual costs of your loan. We'll explain more in a moment – but first, what is the difference between the interest rate and the comparison rate?
What's the difference between the interest rate and comparison rate?
The interest rate is the percentage of interest that you will be charged on your loan. If your loan is $500,000 and the interest rate is 2.75%, you will be charged interest of around $13,750 in the first year of having the loan.
However, the interest rate you are charged doesn't consider all of your costs. There are other costs that your lender may charge, such as:
- Account keeping fees
- Annual package fees
- Loan switch fees (when you move between variable and fixed rates)
- Rate lock fees (when you are first obtaining a loan)
- Government fees and charges
The comparison rate is a percentage amount that is calculated by adding together the interest rate, plus any additional fees and charges that may apply to the loan. The total figure is then converted into a percentage rate to highlight the true cost of the loan.
Lenders are unable to hide any fees, charges or other costs, as these are reflected in the overall comparison rate.
How do you calculate the comparison rate?
If the comparison rate you're given isn't reflective of your loan amount or your preferred loan term, it is possible to calculate this yourself. The comparison rates are actually calculated using a formula that is governed by the Uniform Consumer Credit Code (UCCC).
The calculation is not simple, so you may find that using a good comparison rate calculator, such as our calculator below, will make this easier for you. Before you begin, you will need the following information:
- Loan amount
- Loan term
- Repayment frequency
- Interest rate
- Monthly account fee (if any)
- Annual fee (if any)
- Establishment fee (if any)
- Valuation fee (if any)
- Mortgage documentation fee (if any)
- Settlement fee
When you have all this information, you're able to enter it into the comparison rate calculator and reach a percentage rate that more accurately displays the real cost of a home loan.
How do lenders calculate the comparison rate?
The comparison rate is calculated using a formula that takes into account a number of items. These include:
The actual interest rate charged by the bank for your home loan is the major factor in calculating the comparison rate.
Fees and charges
Many lenders charge a monthly account fee for their mortgage accounts. Some might charge an annual package fee. Some may also charge an establishment fee, valuation fee, mortgage documentation fee and settlement fee. These charges need to be taken into account when calculating the comparison rate, as they do affect the overall cost of the loan.
When it comes to calculating comparison rates, a longer loan term will mean a higher comparison rate. If you see a comparison rate calculated over 25 years, ask to have it reworked to reflect a 30-year term, if this is how long you intend your mortgage to be set for.
The actual loan amount will also be a factor in calculating the comparison rate. Some banks actually offer discounted interest rates on larger loan amounts, so the comparison amount may actually be lower for a bigger loan amount.
The interest on your mortgage is calculated on the outstanding balance every day. This means that paying your repayments more frequently will actually reduce the balance on a more regular basis, which can reduce the overall comparison rate.
What isn't included in the comparison rate?
Multiple factors are taken into consideration in an effort to reveal the true cost of a loan and arrive at a comparison rate. Unfortunately, there are some costs that won't be included in the calculations, even though they are costs that can affect how much your mortgage costs overall. These include:
- Government stamp duty
- Conveyancing fees
- Late payment fees
- Break costs or early termination fees
- Deferred establishment fees
- Redraw fees
How important is the comparison rate?
The example comparison rates on home loans are only guidelines for possible costs. The actual cost of your loan depends on many factors and with legal comparison rates based on an amount of $150,000, there's an argument that they're not very helpful.
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