If you are in the market for a home loan, you will likely compare offers from multiple lenders to choose one that fits your requirements the best. When comparing offers, one of the top things to compare is the interest rate to understand how much you will pay for borrowing money from a lender.
But did you know that a home loan with a lower interest rate may eventually cost you more than a home loan with a higher interest rate but lower ongoing fees? That’s why it’s important to consider the comparison rate in addition to the interest rate to make sure you are comparing apples with apples when shopping around for a mortgage.
What is a comparison rate?
A comparison rate is a more accurate indication of a home loan’s overall cost than the interest rate. It considers the interest rate of a loan and some of the upfront costs and ongoing charges that add to the total cost. Therefore, the comparison rate gives you a better overview of the true cost of a loan than the interest rate.
To ensure a fair comparison, the comparison rate is always calculated on a loan of $150,000 with a term of 25 years. Besides the interest rate, it generally includes the standard fees and charges. The comparison rate also factors in any low introductory rates and the revert rates at the end of the honeymoon period.
Note that it is mandatory for lenders to publish the comparison rate for a loan in addition to the interest rate to help consumers get a better estimate of how much a loan will cost them.
What is the purpose of the comparison rate?
The comparison rate combines the interest rate and some standard fees that come with a loan to make it easier to compare different home loan options. It helps you estimate the true cost of a loan, as a low interest rate doesn’t automatically mean it’s the most economical option.
For example, you may think that Home Loan A with an interest rate of 3% is cheaper than Home Loan B with an interest rate of 3.5%. However, when you look closely, you find Home Loan A’s comparison rate to be higher than that of Home Loan B. This means the fees and charges associated with Home Loan A are higher than Home Loan B and it could end up costing you much more than the latter.
Another example is when you are considering two home loans with the same advertised interest rates. Even though you might think they cost the same, the loan with the higher comparison rate is likely to cost more than the other.
But always remember – the cheapest loan may not be the best for you!
Home loan comparison rates allow you to compare home loans based on cost, making it easier to understand which home loan options are likely to charge higher fees and charges among the alternatives you are considering. However, it isn’t ideal to solely rely on the comparison rate when selecting the right mortgage loan for you.
Comparison rates are modeled on a $150,000 home loan with a term of 25 years. The average home loan size is generally much higher, which means the comparison rate may not match the exact circumstances of your home loan.
Generally, the larger your home loan is, fees will have less of an impact on your borrowing costs. Therefore, instead of looking for the lowest rate on a home loan, it’s advisable to find a loan that matches your unique requirements. For instance, you may have to pay extra for some features and benefits, such as an offset account or free additional repayments and redraws. But paying for these additional features could add some flexibility to your home loan. It is up to you to run the numbers and see whether paying extra justifies the benefits you may reap from using these features in your home loan. It can also help to speak with a mortgage broker to better understand the costs of a loan and what features you need in it to meet your financial goals.
