Lenders must now display comparison rates wherever and whenever they advertise their home loan products. There are two reasons for this rule change.
One is to prevent lenders from displaying misleading rates. The other is to ensure you can see any other costs that lenders may have tried to hide from you in the past.
Even so, many borrowers don’t see the comparison rate when looking for a home loan. Those that do, may not understand what it means for them either.
We, at uno want to demystify comparison rates so you know exactly what you’re looking at.
How do Comparison Rates Work?
Comparison rates are meant to show you the true cost of a home loan. In addition to the loan’s principal, the comparison rate shows any credit fees and interest charges you’ll face. This should give you a better idea of how much taking out a home loan will affect you financially.
Lenders have a legal obligation to display the comparison rate against every home loan product they advertise. This prevents lenders from advertising seemingly cheap rates that come with hidden costs. As such, the rate prevents you from taking out a loan that you may not be able to afford.
On a more basic level, the comparison rate helps you to compare home loans with more accuracy.
What Makes a Comparison Rate?
Now you know what the comparison rate is, you need to understand what it includes. The rate brings together the value of the loan, its interest rate, and any other fees that may apply to the loan. This creates a percentage figure you can use to compare the loan against other products.
Five factors go into creating the comparison rate:
● Interest rate – This defines the actual rate you’ll get and can affect how much you can borrow.
● Loan amount – Many lenders offer discounted rates on larger loans. This can make the comparison rate on large loans lower than it is on small loans.
● Loan term – Comparison rates are calculated under the assumption that the borrower will pay the loan off over 25 years. This is despite the fact that most home loans last for more than 30 years.
● Fees – Most home loans come with fees attached. Among others, these may include fees for establishment, settlement, and valuation. Each affects how much the loan will cost you.
● Repayment rate – Paying the loan back at a faster rate than normal will lower the comparison rate.
● Repayment type – The total cost of the loan will change depending on whether your repayments are Principal and Interest or Interest Only.
The National Consumer Credit Protection Regulations (NCCP) provides a formula that lenders plug these figures into. This creates the comparison rate.
What Isn’t Included?
You also need to know about the fees that aren’t built into the comparison rate. These will likely include the following:
● Early repayment costs – These are fees that you may have to pay if you end your fixed rate home loan during the fixed rate period.
● Redraw costs – You may have to pay a fee for redrawing during the fixed loan period.
● Stamp duty – This is a governmental fee that 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 advisor to find out if you’re eligible.
● 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 uses the assumption that 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. This fee isn’t part of the comparison rate because it is outside the lender’s control.
You need to account for these fees, because they aren’t used in the comparison rate. Each 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 that 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 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 That Don’t Have Comparison Rates
There are some home loan products that don’t have comparison rates, though you will only come across them in special circumstances.
The loan won’t have a comparison rate if it is not 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 may not use comparison rates for no doc loans and business loans.
Finally, you may not see a comparison rate if you’re taking out the loan to buy shares, or complete a similar transaction.
Other Ways to Compare
Comparison rates provide a useful tool, but they’re not infallible. The failure to take several important fees into account means they aren’t fully accurate.
Beyond 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 the loan, which is something the comparison rate doesn’t always show.
The NCCP provides a formula you can use to create a more accurate comparison rate based on your own circumstances. We, at uno can also help you to compare home loans so you get the best deal.
Useful Comparison Tips
So, what else can you do to figure out how your loan will affect you financially? Here are a few useful tips:
● Consider all the costs associated with the loan, from those built into the comparison rate through to those the 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 to find out how much you’ll pay. There are two things you can do to paint a more accurate picture:
This information is general in nature, and you should always seek professional advice when making financial decisions.