Interest rates vs. Comparison rates:
What's the difference?
Estimated read time: 3 Minutes
Interest rate alone doesn’t tell you the full story when it comes to your home loan costs. That’s where the comparison rate can help.
Your home loan’s interest rate is one of the biggest factors in your monthly repayments and how much you will pay over the life of your loan. But while a low interest rate might look great at first, once you add in fees and charges, you might not end up saving as much as you think.
That’s why it’s important to look at the comparison rate, not just the interest rate. But what is a comparison rate and how can it help you find the best home loan to fit your needs? Let’s find out.
What is a comparison rate and how is it different from the interest rate?
While the interest rate shows the amount of interest you will pay as a percentage of your home loan, a comparison rate shows the interest and any home loan fees and other costs you will pay. That’s why the comparison rate is usually higher than the advertised interest rate.
The comparison rate is there to help you compare different loans accurately, without having to worry about any surprises. A low interest rate with a high comparison rate means a loan is likely to come with high costs and fees outside of interest, so it’s always a good idea to look closely at the terms and conditions to make sure you understand the true cost of your loan.
What does the comparison rate cover?
The comparison rate covers the one-off and monthly fees you will pay on your loan over the course of your term. These typically include:
- Application fees
- Valuation fees
- Loan establishment fees
- Legal fees
- Settlement fees
- Monthly account keeping fees
- Admin fees
- Discharge fees
Note: Not all lenders and loans will charge every type of fee, so the comparison rate will only include the fees and charges that apply to the specific loan you are looking at.
What isn’t covered in the comparison rate?
While the comparison rate includes ongoing fees that are accurate as of the time the loan is advertised, it’s important to understand that it doesn’t include everything.
The comparison rate doesn’t usually include:
- Other fees associated with buying a property including stamp duty and home loan risk fees.
- Fees for features you might not use, such as a redraw facility.
- Fees or charges that were brought in after the comparison rate was advertised.
- Interest offset arrangements and other features that can reduce the overall cost of the loan.
It’s also important to be aware that if you’re on a variable rate loan, the interest rate may fluctuate and cause the amount you pay each month to change.
How do lenders calculate the comparison rate?
All comparison rates are calculated based on a secured loan amount of $150,000 over a 25 year loan term. This creates a level playing field on which you can compare different loans. There’s a good chance you are looking to borrow more than $150,000 – most people these days are. If this is the case, or if you want a different loan term, the comparison rate may not be strictly accurate. Even so, it will give you an idea of which loan is likely to be better value for your situation so you can narrow down your options.
For example, if a home loan offers an advertised interest rate of 5.80% and fees and charges add up to 0.10% a year, the comparison rate will be 5.90%.
However, if another home loan advertises an interest rate at 5.60% and fees and charges add up to 0.40% a year, their comparison rate will be 6.00% – making the overall cost higher than the first home loan.
Why is the comparison rate important?
It’s easy to be drawn in by a low interest rate, but if you don’t read the fine print, you could be setting yourself up to pay more than you realise. Comparison rates could help you avoid this and increase the likelihood you’re getting a loan that suits your budget and circumstances.
By looking at the comparison rate, you can make a better-informed decision as to which loan will cost more over the long-term. If you come across a loan that has a low advertised interest rate and a high comparison rate, it could be a good idea to look more closely at the fees and charges before you commit to anything.
Contributor | Anthony Moir, Treasurer
Anthony joined Pepper Money in February 2021 as Treasurer. With over 25 years of experience in treasury and debt capital markets, he has worked with a diverse range of bank and non-bank lenders. Read more.
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