Understanding Home Loans: What is a Comparison Rate vs Interest Rate?
Are you in the market for a home loan? If so, you’ve probably noticed lenders advertising an interest rate vs comparison rate…and you’re probably wondering what that means. Most people are familiar with how interest rates work, but what is a comparison rate? And why do you need to compare the interest rate vs comparison rate on home loans?
There seems to be a lot of confusion around comparison rates vs interest rates. “What is a comparison rate?” is a question that mortgage brokers now get asked all the time! And while the whole ‘comparison rate vs interest rate’ equation may look confusing, it’s actually quite simple. Comparison rates can be a valuable tool for anyone looking to refinance or take out a new loan. Why? Because they could ultimately end up saving you a lot of money.
What is a Comparison Rate?
When looking for a new home loan, it can be tempting to just compare interest rates. And while interest rates are important, they don’t necessarily tell you which loan offers the best value long term. The home loan with the lowest interest rate might also include the highest fees. This is why it’s important to understand exactly what a comparison rate is.
A mortgage comparison rate is a figure that all lenders, by law, must display next to their advertised interest rates. It is designed to help you understand the overall cost of a loan and make it easier to compare loans from different lenders. How does a mortgage comparison rate do this?
Unlike an advertised interest rate, comparison rates factor in some of the additional fees and charges that come with a home loan. This means that comparing the interest rate vs comparison rate will give you a more accurate representation of how much you can expect to pay.
What is the Difference Between an Interest Rate vs Comparison Rate?
The key difference between an interest rate and a lender’s comparison rate is found in the included costs. A home loan interest rate only reflects how much interest you will be charged on the balance of your loan. This rate is used to determine your minimum monthly home loan repayments.
In contrast, a mortgage comparison rate compares the overall cost per year of the loan. This factors in many of the fees and charges you have to pay at the start of the loan, as well as ongoing fees owed throughout the year (such as annual fees).
In summary:
- What is an interest rate? Interest rates show how much interest the lender will charge you per year. This rate will determine your monthly repayments.
- What is a comparison rate? Comparison rates show how much you’ll be charged by the lender per year, including most standard fees and charges. This helps to determine your total mortgage costs over the course of a year.
Once you understand how a comparison rate is calculated, you can assess the cost difference between available home loan products.
What is Included in a Mortgage Comparison Rate?
A comparison rate will typically include a range of fees and charges that will apply throughout the life of the loan. It calculates:
- The total amount of the home loan.
- The length of the loan term.
- The frequency of your repayments.
- What your home loan interest rate is.
- Any applicable fees and charges (including establishment fees and annual costs).
What Does a Comparison Rate Not Include?
A comparison rate is designed to help consumers compare various mortgage products using an “apples for apples” formula. While it can be a useful tool, it’s important to view it as a guide only. This is because the comparison rate won’t necessarily include all associated loan costs. For example, it usually won’t include:
- Government charges, such as stamp duty or mortgage registration fees.
- Fees and charges associated with loan options or events that may not be used by the borrower (such as early repayment or redraw fees).
- Fees and charges that aren’t available at the time the comparison rate is provided.
- Cost savings, such as fee waivers or the availability of interest offset arrangements could influence the cost of a loan.
Why Pay Attention to the Comparison Rate vs Interest Rate?
Understanding what a comparison rate is will help you make a more informed decision as a consumer. By looking at the comparison home loan rates, you might be surprised to see that the loan with the lowest interest rate isn’t always the cheapest option.
While examining comparison rates is a good place to start, it shouldn’t be the end of your mortgage evaluation. It’s also important to consider other features of the loan to see if it will provide you with the best possible solution. If this amount of homework sounds daunting, then don’t panic.
An experienced mortgage broker can do all the hard work for you. By comparing a wide range of loan products and offering tailored expert advice, a mortgage broker can make sure you’re getting the best deal to suit your needs. This could ultimately save you thousands of dollars over the life of the home loan.
A Case Study Comparing Interest Rates Vs Comparison Rates
Let’s consider a hypothetical case study that illustrates the importance of comparing all the relevant details of a mortgage product. Alex wants to apply for a mortgage to buy a new home. A broker helps Alex to compare two home loan products, both with 25-year terms, but with different interest rates, comparison rates and loan features.
Loan A:
- Interest Rate: 4.7%
- Comparison Rate: 5.1%
- Loan Features: No ongoing fees, but this loan has a higher upfront establishment fee compared to Loan B. It also offers a redraw facility and would allow Alex to make additional repayments without having to pay any extra fees.
Loan B:
- Interest Rate: 5.2%
- Comparison Rate: 5.5%
- Loan Features: Lower upfront establishment fee compared to Loan A. It has a moderate ongoing annual fee. While it doesn’t have a redraw facility, it offers a fixed interest rate for the first five years, providing stability in repayments.
Alex’s Considerations:
- Interest Rates: Alex notices that Loan A has a lower interest rate (4.7%) compared to Loan Product B (5.2%). At first glance, this might make Loan Product A seem more attractive.
- Comparison Rates: However, the broker then points out the comparison rates. Loan A has a comparison rate of 5.1%, while Loan B has a comparison rate of 5.5%. This suggests that (accounting for fees and charges), Loan A might be a more cost-effective option over the life of the loan.
- Loan Features: Next, they consider the loan features. While Loan A has no ongoing fees and allows for additional repayments, Loan B offers a fixed interest rate for the first five years, providing budget certainty. However, Loan B doesn’t allow for redraw, and Alex is hoping to renovate the house within the next 5 years.
- Overall Assessment: Despite the slightly higher interest rate, Loan A appears to be the better option thanks to its lower comparison rate and more suitable features. Alex plans to make additional repayments for a few years, and then use the redraw facility to finance the proposed renovation.
This scenario shows why it’s important to consider both interest rates and comparison rates, along with loan features, when choosing a home loan product.
What is a Comparison Rate? Learn More from an Experienced Broker
Comparison rates play an important role in evaluating loan products, but they won’t tell you what’s the best possible loan product to suit your circumstances. For example, is your Loan-to-Value Ratio (LVR) under 80%? Are you self-employed?
Are you prepared to review your home loan every 2-3 years, especially once the fixed interest rate term has ended? If you answered “yes” to any of the above questions, then the comparison rate alone won’t tell you everything you need to know about which mortgage is right for you.
The experienced team at North Brisbane Home Loans is committed to helping our customers find the right home loan to suit their circumstances. This includes being aware of the best deals currently available and understanding how to get them. If you’re interested in learning more about what is a comparison rate, or you’re looking for expert home loan advice, then contact us today or book an appointment online.
Patrick Cranshaw, a Certified Mortgage Professional for over 21 years, founded North Brisbane Home Loans in 2002. His career began with ANZ Bank in New Zealand, where he progressed over 16 years to a Business Banking role in Virginia. After moving to Brisbane in 2000, Patrick led the QLD market for a home loan agency, helped set up the REMAX Real Estate Finance division, and practiced as a broker.
