Getting the right home loan is tough enough without being deceived about how much it will actually cost you over 25 or 30 years. That’s why lenders are forced to provide comparison rates whenever they advertise their home loan products.
The comparison rate helps you identify the true cost of your home loan. In one percentage figure, you can get a guide to what you’ll be paying – taking into account the headline interest rate and many of the fees and charges associated with the loan. This allows you, in theory anyway, to compare loans from different lenders.
Understanding comparison rates is important for borrowers because they help prevent lenders displaying misleading “advertised” rates. They also ensure borrowers can see any costs that lenders may have once tried to hide.
Even so, many borrowers don’t get to see the truest comparison rate when they’re looking for their ideal home loan. At uno, we want to demystify comparison rates so you know exactly what you’re looking at … and how to get the best deal.
How do comparison rates work?
Since July 2003, lenders have had a legal obligation to display the comparison rate on every home loan product they advertise. By expressing the “true cost” of a loan in a single percentage figure – taking into account the interest rate and most fees and charges – borrowers have a better idea of how much the lending arrangement will impact on their finances over the length of the loan.
This prevents lenders from advertising seemingly cheap rates that come with hidden costs. As such, the rate prevents you taking out a loan that you may not be able to afford. On a more basic level, a comparison rate can help you compare home loans more accurately.
But there’s a major limitation: comparison rates are based on a formula that only compares principal-and-interest loans for $150,000 over 25 years. If your loan doesn’t exactly fit this formula – and, well, it’s not likely to – the actual amount you pay will be quite different. As we said, it’s only to be used as a guide … not as gospel.
How do lenders arrive at a comparison rate?
The comparison rate brings together the value of the loan, its interest rate and any other fees that may apply to the loan. As mentioned, it is only calculated on a 25-year, $150,000 loan. This generates a percentage figure you can use to try to compare one loan against others.
There are four factors that go into creating the comparison rate:
- Headline interest rate – what the lender is offering in the deal.
- Repayment frequency – how often you’re asked to service the loan.
- Fees – costs such as annual fees, establishment fees, valuation fee, mortgage documentation fees, settlement fees and account-keeping fees.
- Loan type – whether the loan is fixed or variable, and if there is an interest-only period, for example.
The Australian Securities and Investments Commission administers the comparison rate formula under the federal National Credit Code.
What isn’t included when assessing the comparison rate?
Some factors aren’t built into the comparison rate. These are likely to include:
- Stamp duty – this government charge varies from state to state. You can use our stamp duty calculator to find out how much you need to pay. Also, some states have programs in place that could help you avoid stamp duty, so speak to an adviser to find out if you’re eligible.
- Some fees and charges – costs such as early termination fees or redraw fees during a fixed-loan period, for example.
- Lenders Mortgage Insurance (LMI) – lenders usually apply LMI to any home loan that is worth 80% or more of the property’s value. The comparison rate assumes the loan is for 80% or less of the property’s value.
- Any other legal fees or charges – you’ll usually need to hire a solicitor or conveyancer to complete your home purchase. These fees aren’t part of the comparison rate because they are outside the lender’s control.
Each of these factors needs to be considered in conjunction with the comparison rate. All can affect your borrowing power and how much you will spend to take out a loan.
The difference between comparison rates and interest rates
Don’t make the mistake of thinking the comparison rate and interest rate are one and the same.
The interest rate is just the percentage of the loan that you need to pay on top of the actual loan amount (the principal). The comparison rate stretches further. It incorporates the interest rate and several other fees to create a more accurate indication of the loan’s true cost.
Loans without comparison rates
Some home loan products don’t have comparison rates, although you will only come across these in special circumstances.
A loan won’t have a comparison rate if it isn’t regulated under the National Consumer Credit Protection Act (NCCP). Very few lenders offer these types of loans, and borrowers should try to avoid them.
Lenders might not use comparison rates for no-doc loans and business loans.
Other ways to compare loans
The comparison rate is a useful tool but it’s not perfect. Because it’s set at a specific loan size and term and doesn’t include several important fees it isn’t entirely accurate. It’s to be used as a guide only.
The simple fact is that comparison rates don’t take your personal situation into account. You’ll find that the length of the loan and the amount you want to borrow will change the true cost of your loan, and the comparison rate formula isn’t equipped to deal with this.
The best idea is to talk to us at uno. We can help you compare home loans so you’ll find the best deal.
Useful comparison rate tips
So, what else can you do to figure out how your home loan will impact on your finances over the long term? Here are some useful tips:
- Consider all costs associated with the loan, from those built into the comparison rate through to those your lender has no say in.
- Alter the rate depending on your loan term, rather than the 25-year standard term used in the comparison rate.
- Keep your own goals in mind to find a loan that meets your needs.
- Check the external factors that could affect your borrowing power, such as the type of loan and any added features.
What to do next
The comparison rate offers you a better idea of the real cost of your home loan, but there’s more you can do:
This information is general in nature, and you should always seek professional advice when making financial decisions.