Sick of hearing about comparison rates whenever a home loan is mentioned? You shouldn’t be, because the comparison rate is extremely important.
- What is a comparison rate?
- Comparison rate vs interest rate
- How is it calculated?
- Why is it important?
Between the Reserve Bank and home loans, the term ‘interest rates’ has migrated from the finance sector to become a regular part of our vocabulary. Perhaps yet to make this migration is the term ‘comparison rate’. This is despite the two going hand in hand and comparison rates being arguably the more important of the two.
This article will try to break comparison rates down into simple terms so you can be in the know when next shopping around for a home loan.
Compare home loan rates
Base criteria of: a $400,000 loan amount, variable, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. If products listed have an LVR <80%, they will be clearly identified in the product name along with the specific LVR. The product and rate must be clearly published on the Product Provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 18 May 2020. View disclaimer.
What is a comparison rate?
A comparison rate – also known as the Average Annual Percentage Rate (AAPR) – is a rate which helps provide a better indication of the true cost of a loan by bundling the interest rate plus various fees into a single percentage figure.
From 1 July 2003, amendments to the Consumer Credit Code made it mandatory for lenders to disclose comparison rates for home loans. This was done in order to force a degree of honesty among lenders, so they’re not able to hide extortionate fees while advertising low rates. The legislation allows for borrowers to better compare home loans between lenders, taking a small amount of the hassle out of applying for a mortgage.
Of course, not all home loans are created equal, so comparison rates are uniformly calculated based on a loan amount of $150,000 with a loan term of 25 years. And herein lies the biggest weakness of a comparison rate. Data from CoreLogic in June 2019 found the median value of a dwelling in Australia was $516,713, so it’s quite likely you’re going to be borrowing more than $150,000.
It’s also common that borrowers will choose a loan term greater than 25 years, with 30 years being a popular choice, while some lenders even offer loans up to 40 years. So even if you encounter a comparison rate you think is great for you, take it with a grain of salt until you apply your own circumstances to it.
Interest rate vs comparison rate: what’s the difference?
Think of the interest rate as the small picture and the comparison rate as the big picture. The interest rate on a home loan, often referred to as the advertised or headline rate, is typically what the lender will advertise the most and what punters are most familiar with. It refers to the rate of interest you will be charged on the loan balance per year and affects how much your minimum monthly repayments will be.
In contrast, the comparison rate represents the overall cost per year of the loan, including most (see below) of the fees and charges that will occur over the course of the loan. It also includes the interest rate itself.
How do you calculate the comparison rate?
Comparison rates are calculated using a formula set out by the Uniform Consumer Credit Code (UCCC). The calculation itself is quite complex, so it’s advised you use an online comparison rate calculator, where you simply plug in all of the information and it does it for you.
It’s worth noting that the values set out below are for home loan comparison rates. Car loan comparison rates are usually based on a $30,000 loan amount over a five-year term, while personal loans are usually based on $10,000 over three years.
The factors that go into the calculation for home loan comparison rates are:
As mentioned, this is a mandatory $150,000 amount.
As above, the comparison rate sets the term at a mandatory 25 years.
This is typically monthly.
This will come down to the product the lender is offering.
Some of these fees may not apply based on the lender and product
- Monthly account fee
- Annual fee
- Establishment fee
- Valuation fee
- Mortgage documentation fee
- Settlement fee
What doesn’t the comparison rate cover?
The comparison rate isn’t an all-encompassing finance beacon of light – it has its pitfalls. Some costs aren’t included in the calculations, despite them likely affecting your mortgage costs. These include:
- Government stamp duty
- Conveyancing fees
- Fee waivers
- Break costs and early termination fees
- Deferred establishment fees
- Any optional costs such as early repayment and redraw fees
- Extra features like offset accounts or extra repayments
So essentially, the comparison rate doesn’t include non-mandatory costs or costs you incur separately from the home loan, like stamp duty. These costs are worth factoring into your decision to buy since they can end up being quite expensive.
Why is the comparison rate important?
The average Australian generally doesn’t have a great wealth of knowledge when it comes to banking or home loans. He or she also doesn’t have the time to carefully peruse the terms and conditions of a product, to be sure there are no fees hidden on page 36 of a home loan document, written in size 6 font and italics.
Comparison rates give borrowers a full deck to play with when it comes to home loans, rather than a couple of jokers the lender may deal you. The information comparison rates provide is crucial, as just a marginal difference in the interest rate on your loan can cost tens of thousands of dollars.
As you can see in the overly simplified table below, home loan A has a better interest rate than home loan B.
However, once the various fees and charges have been accounted for in the comparison rate, home loan B is a far cheaper product than home loan A.
|Interest rate||Fees & charges||Comparison rate|
|Home loan A||3.35%||1.00%||4.35%|
|Home loan B||3.50%||0.50%||4.00%|
Where do you find the comparison rate?
It’s mandatory that lenders display the comparison rate when advertising loans. This includes personal loans and car loans, as well as home loans.
It’s usually beside the headline rate, so for example “3.00% p.a. variable rate (3.50% p.a. comparison rate)”.
All lenders must also provide a key facts sheet on the product they’re offering, which has to specify the comparison rate, interest rate, and the total amount to be repaid over the life of the loan.
Here’s a super simplified hypothetical situation, to show you in real-world terms, the application of comparison rates.
Cam Parison has found an apartment that doesn’t have any construction problems for $400,000. He wants to buy it and has saved up $80,000 for a deposit, and is looking to borrow $320,000 over 30 years. He’s found two products he likes from lenders ‘Connbank’ and ‘Not A Bank’,
However, the lenders are engaging in extremely illegal practices and not showing the comparison rate, so he decides to calculate them himself.
‘Connbank’ is offering a three-year fixed-rate mortgage. The fixed-rate is 3.00% p.a. and then switches to an ongoing rate of 3.50% p.a. at the end of the three-year fixed period. There is a $40 monthly fee, a $500 upfront fee and $300 discharge fee.
Cam calculates that the comparison rate will then be 3.65% p.a.
‘Not A Bank’ is offering a variable rate mortgage with an interest rate of 3.25% p.a. The only fee is a $50 monthly fee. Cam calculates that the comparison rate will then be 3.53% p.a.
Borrowing from ‘Not A Bank’ over ‘Connbank’ would save Cam up to $7,549 over the course of the loan.
Savings.com.au’s two cents
Although we’ve championed the comparison rate as a home loan hero, there are lots of other things to consider when choosing which product is right for you.
- Always consider the type of loan, like whether it’s a fixed or variable rate or even if it has an introductory rate.
- Check what types of features it has, like offset accounts and split loan facilities
- Also check the conditions associated with it, like whether there’s a cap on extra repayments
The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:
- The big four banks are: ANZ, CBA, NAB and Westpac
- The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
- The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.
In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.
*The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.
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