When you see home loans advertised, you'll see an interest rate and a comparison rate. These two rates are often different, which may have you asking what are comparison rates?
If this is your first time looking at home loans or any type of loan, you may not understand how comparison rates work. You also won’t know how they're calculated, how they're different to interest rates, and what you should consider when looking at comparison rates. Understanding these things will help you make a more informed decision when getting a home loan.
A comparison rate is displayed as a percentage rate, and it includes the interest and most fees and charges you will have to pay with your loan. Lenders are required by the National Credit Code to show a comparison rate alongside the interest rate they will charge for your home loan.
Comparison rates were introduced by the Australian government to help borrowers better understand the total cost of a loan. It is meant to help inform borrowers of the true cost of credit products and make it easier for them to compare like for like when it comes to what’s available in the market.
Interest rates are the rate your lender will use to calculate your interest on your loan when working out your minimum repayment as per your loan contract. A comparison rate is displayed as a percentage, but the lender uses a calculation that includes the interest rate and a set of fees and charges you'll be charged to work out what the comparison rate is.
To calculate the comparison rate of a particular loan lenders are required to use a $150,000 loan over a 25-year loan term. To calculate the comparison rate a lender will take:
There are other costs associated with mortgages that aren’t included in calculating comparison rates which also need to be considered. These include:
The lender may also offer other features that make a loan more attractive that wouldn’t be included in the comparison rate calculation. This may consist of fee-free accounts such as an offset account or flexible repayment options.
When it comes to comparison rates, you have to remember that lenders all use the same formula to calculate them in terms of loan size and term. This helps to keep things consistent across the market but means they might not be reflective of an individual’s circumstances. This doesn’t mean you can’t use comparison rates to gauge the suitability of one mortgage over another. It just means you need to consider your own circumstances when comparing the rates.
If you’re comparing home loans, you can use a comparison rate as a quick way to work out if a loan has more fees than another loan. If a comparison rate is considerably higher than the advertised interest rate, it would be an indicator to look closely at the fees applied to the loan.
To get a more accurate idea of the cost of your home loan, you'd be better off using an online mortgage repayment calculator. You can enter your loan size, loan term, loan type and the advertised interest rate to find out how much repayments may be or how much interest you'll pay over the life of your loan.
If you’re ready to look at some of the interest and comparison rates, you can check out Yard's range of home loans here.