While many people talk about home loan interest rates, far fewer people talk about comparison rates. This is unfortunate, as home loan comparison rates can make a big difference when you’re estimating the costs of different mortgage options, whether you’re applying for your first home loan or refinancing.
What is a comparison rate?
A comparison rate is an indication of a home loan’s overall cost, combining its interest, fees and other standard charges into a single percentage rate.
Looking at the comparison rates of two or more home loans can help you estimate at a glance which mortgages may end up costing you more or less money in overall costs.
From July 2003, the Australian government made it mandatory to display a comparison rate alongside an advertised interest rate, whether that’s for a home loan, personal loan, credit card, car loan, or other form of credit.
How are home loan comparison rates calculated?
To ensure that home loan comparison rates remain consistent across the mortgage market, they are calculated from the same starting point.
A home loan comparison rate assumes:
- A loan of $150,000
- A 25 year loan term
- Principal and interest repayments
The comparison rate is calculated using these assumptions, factoring the following costs:
- Interest rate
- Standard fees and charges
- Factors affecting the above (e.g. low introductory “honeymoon” rates, and the revert rates that follow when they expire)
All of these factors are combined to work out the approximate total cost of this example home loan, which is expressed as a single percentage of the loan value, just like an interest rate – this is the comparison rate.
At first glance, a home loan with an interest rate of 8% may appear cheaper than a home loan with an interest rate of 8.25%.
However, if the first home loan’s fees and charges cost approximately the equivalent of paying 0.5% extra interest, and the second home loan’s fees and charges cost approximately the equivalent of paying just 0.1% extra interest, the second loan could end up costing less in total than the first loan.
|Home loan||Interest rate||Fees & charges||Comparison rate|
|Home loan A||8%||0.5%||8.5%|
|Home loan B||8.25%||0.1%||8.35%|
Is a comparison rate accurate?
While a comparison rate can help you get a general idea of whether one home loan option is likely to have higher fees and charges than an alternative option, it may not give you a 100% accurate estimation of your home loan’s total cost.
This is partially because the assumptions used to calculate a comparison rate may not match the circumstances of your home loan. For example, comparison rates are calculated on the assumption of a $150,000 home loan, when the average owner-occupied home loan in November 2017 was $388,900, according to the Australian Bureau of Statistics (ABS). The larger a home loan, the smaller the impact that fees and charges are likely to make on the total cost compared to the interest rate.
It’s also important to remember that a comparison rate doesn’t necessarily include every cost of a home loan, as some mortgages have nonstandard charges to consider, such as fees associated with loan options that you may not choose to use (e.g. early repayment fees or redraw fees).
Finally, a comparison rate doesn’t account for some of the extra features and benefits offered with some home loans, such as an offset account – you’ll need to decide for yourself whether this potential extra value justifies any extra cost.
While a comparison rate can be useful for making a quick and simple comparison of home loan costs, for a more accurate summary of a home loan’s overall cost, you should use a home loan repayment calculator, such as RateCity’s, or MoneySmart’s . Alternatively, get in touch with a home loan expert or mortgage broker.