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What is a comparison rate?
A comparison rate takes into account the fees and the interest rate on a home loan. In theory it can tell you the true cost of the loan but in reality you're better off doing your own calculations.
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A comparison rate is a percentage rate that all lenders must display by law, next to their advertised interest rates. It's a rate that takes into account most of the fees and charges of a home loan. It's designed to give you a more accurate picture of a loan's true cost once all of the fees and charges are taken into account.
Unfortunately, the comparison rate doesn't always help borrowers much. The rate is calculated on a hypothetical loan that might look nothing like yours. To really understand your home loan costs you should use a repayment calculator and factor in the cost of fees yourself.
What is a comparison rate?
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
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:
Interest rate
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.
Loan term
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.
Loan amount
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.
Payment frequency
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
Why the comparison rate isn't a good comparison anymore
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. This is why advertised comparison rates may not be especially helpful when you're working out your true loan costs.
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. Changing the terms or length of a loan can have a significant impact on the loan's comparison rate. With this in mind, it pays to generate your own comparison rate for your expected borrowing amount, with the lenders you're considering. The advertised comparison rate can be a helpful tool when you're considering home loans, but if you don't take the time to dig a bit deeper, you could end up paying thousands of dollars more.
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