What is a comparison rate?
How a comparison rate helps you judge the true value of your mortgage.
A comparison rate is a rate that all lenders by law must display next to their advertised interest rates. It's a rate which takes into account some of the fees and charges of a home loan to give you a more accurate representation of a loan's interest rate once the costs are taken into account.
A comparison rate on a home loan is usually worked out using the example loan of $150,000 over 25 years. Personal loan comparison rates usually have an example loan of $30,000 over 5 years.
Comparison rates were made mandatory in an attempt to stop lenders from advertising incredibly low interest rates that lured unsuspecting borrowers into loans that actually cost them far more than they expected.
What's the difference between the interest rate and comparison rate?
The interest rate is the percentage amount most people take notice of when they try to compare home loans. This is the percentage of interest that you will be charged on your loan. But it doesn't consider all your costs. The comparison rate is a percentage amount 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 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 all into a good 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 a 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 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. So there's an argument that they're not very helpful.
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