A comparison rate is a percentage rate that all lenders must display by law, next to their advertised interest rates. The rate more closely reflects what you'll actually pay on top of your principal loan repayments over the year, by taking into account the interest rate plus most of the fees and charges you'll pay.
Unfortunately, the comparison rate doesn't necessarily 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 - or use our calculator below!
Comparison rates were made mandatory in an attempt to stop lenders from advertising very low interest rates that lured borrowers into loans that cost them far more in the long run.
For instance, a lender might have advertised a low mortgage interest rate of 5.5%, 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 5.6%, but with no fees.
A comparison rate on a home loan is legally mandated to be calculated based on:
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 5.75%, you will be charged interest of around $28,750 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:
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.
| Response | |
|---|---|
| Yes | 59.98% |
| No | 40.02% |
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 the major factor in calculating the comparison rate.
Many lenders charge fees like monthly account fees, annual package fees, establishment fees, valuation fees, mortgage documentation fees and/or settlement fees.
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 for your own loan term (this is often 30 years).
Some banks actually offer discounted interest rates on larger loan amounts, so the comparison rate may actually be lower for a bigger loan amount.
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.
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:
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.
The comparison rate can be an important factor to look at, but there are a couple of reasons it might not be.
Firstly, it doesn't take into account all of the extra fees you'll pay.
Those fees include:
Secondly, back when comparison rates were introduced in July 2003, these figures made much more sense. Today, the average loan size is much more than the $150,000 they're based on: the latest stats put the current average loan size above $500,000.
The average loan term for the majority of borrowers is also 30 years, not 25 years.
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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