It can be confusing to understand what rate a lender will charge you. The interest rate, or the comparison rate? What is a comparison rate, and why is it usually higher than the actual interest rate?
What is a comparison rate?
A comparison rate is a percentage rate that can help you work out the true cost of a loan. It takes into account some of the fees and charges to give you a closer estimate of the total cost of the loan.
In addition to helping you understand what you’re paying for, it’s there to make lenders more accountable and transparent when communicating the loan’s costs. Lenders are required by law to let you know what the comparison rate is.
What’s the difference between a comparison rate and interest rate?
Put simply, the interest rate is what you’re charged each year on your borrowed amount but it doesn’t consider the costs, whereas the comparison rate is an overall rate that provides a more accurate representation of the true cost of the loan – it includes the interest rate and those costs, fees and other factors we’ve mentioned above.
How are comparison rates calculated?
Ok so on those costs, fees and other factors, lenders are required by law to use exactly the same variables when calculating their comparison rates. You’ll see it summarised in the fine print as – “Comparison rate based on a loan amount of $150,000 over 25 years”.
The following variables are used when calculating comparison rates:
Why is a comparison rate important?
The loan with the lowest interest rate isn’t necessarily the cheapest home loan. Comparison rates were made mandatory to stop lenders advertising appealing low interest rates that actually cost far more than what borrowers expected.
The variables used to calculate a comparison rate could change an appealing advertised annual interest rate to something much less competitive and attractive. It can be a really useful tool when comparing apples with apples.
Remember to consider your personal circumstances
Aussies borrow a lot more than $150,000 on average, and not everyone’s loan term is 25 years. Some of us pay it off fortnightly rather than monthly, too. So when you consider all these factors, the advertised comparison rate most likely won’t reflect your situation.
That’s why you’ll see this friendly caveat with comparison rates –
“WARNING: Comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Comparison rates for variable interest-only loans are based on an initial 5 year interest only period. During an interest-only period, your interest only payments will not reduce your loan balance. This may mean you pay more interest over the life of the loan.”
This means that you should use the comparison rate as a ‘like for like’ guide rather than the definitive guide for your circumstances.
How to compare home loan rates
Using your own numbers and situation, take our calculator for a spin to see what you’d pay for home loan and what you could save compared to other loans. Do the same with other lenders, so you can see what repayments look like if you’re stuck with a heftier comparison rate.
If you’re not with a lender who has your best interests at heart, consider switching to one who will.