This is a complete guide to Comparison Rates.
In today’s guide you’ll learn:
- What a Comparison Rate is
- How to Find the Best Comparison Rate
- Dozens of Comparison rate best practices
In short: if you want to understand how comparison rates work and what the hype is all about, you’ll love this new guide.
1. Comparison Rate Basics
In this chapter, I’ll help you get clear on exactly what a comparison rate is.
So if you’re not sure how exactly these rates work, then your questions will be answered.
Then, in later chapters, I’ll show you a bunch of research strategies and how to use comparison rates to your benefit.
What is a Comparison Rate?
A comparison rate is a way to represent the total cost of your loan.
According to ASIC a comparison rate turns the cost of your loan fees, interest rates and other charges into a percentage.
In fact, the rate is there to show the true cost of your loan, and it’s used to compare different loans.
But what’s the catch?
The comparison rate doesn’t take into account things like payment terms, upfront fees, establishment fees and other associated costs.
So in reality, it can miss out a lot of extra costs.
What does a comparison rate cover?
There are a few key things that the comparison rate covers including:
- ✅ The interest rate of the loan
- ✅ Fees
- ✅ Loan terms
- ✅ Loan amount
- ✅ Frequency of repayments
So briefly put, a comparison rate is a good way for borrowers to be able to compare between loans.
It gives a nice estimate of all costs involved.
But something to remember is that this is just one part of the loan, don’t forget about all the other features in line with the borrower’s financial preferences.
For example, if any of the below features are important to you, a comparison rate doesn’t take these into account.
So in actual fact, if these are more of a priority for you, then that’s where a comparison rate doesn’t help including understanding if there is:
- ⛔️ Understanding the true costs of all loan amounts – All advertised comparison rates are based on a $150,000 loan over a 25 year loan term, so if you are going to make extra repayments to your loan or are borrowing a higher amount the Comparison Rate won’t be a true representation of the actual costs on your loan.
- ⛔️ Redraw Facility – If a loan offers a redraw facility, you would probably choose it despite the higher comparison rate. Redraw facility provides you access to the extra cash you deposit in the home loan.
- ⛔️ Offset Account – A person should only choose a loan that is in line with his financial goals. You may choose a loan despite the higher comparison rate if it has a linked offset account. An offset account is basically a transaction account that is connected with a mortgage account. It decreases the overall interest payments because the interest rate is applied to the net balance. The net balance is equal to a mortgage balance less the balance of offset account.
- ⛔️ Opportunity to Make Extra Repayments – There are some loan packages that allow a borrower to make extra repayments. This offers flexibility to a person and makes it easier for him to meet his financial obligations.
In order to get a more in-depth understanding of whether a better comparison rate has priority over these kinds of features, chat to our team of mortgage brokers.
We will explain the comparison rate mechanism in detail, and tell you the impact of this rate on repayment terms of a loan and explain other features as well.
What is the difference between the comparison rate and interest rate?
To most people, the difference between a comparison rate and an interest rate is unclear.
But there are two keywords that will help you differentiate between the two.
And those are true cost.
An interest rate simply looks at the interest on the loan, and nothing more.
While the comparison rate is about figuring out the true cost of the loan. It compares loan fees and charges, term and repayment frequency.
See, the thing that catches a lot of people by surprise is that a lower interest rate doesn’t always mean it’s the best loan option.
So this is where a comparison rate comes in.
Then as I said in the previous point, there are other costs that come into play such as other features that may be more beneficial to your personal circumstances. These can have more weight on decision making.
2. How Comparison Rate is Calculated
To understand a comparison rate entirely, you need to understand how a comparison rate is calculated.
Fortunately, figuring it out is easy.
And in this chapter, I’m going to lay out a few different ways comparison rates vary and the effect they have on your decision making.
How is the comparison rate calculated?
A comparison rate can be calculated pretty much in three steps.
In fact, no matter the loan size the basic formula includes these three things:
- ✅ The loan amount – let’s say your loan is $500,000
- ✅ The loan term – the standard home loan term is 30 years
- ✅ Whether it’s principal and interest, or an interest only loan (for this example, let’s say P&I)
So for a Commonwealth Bank Extra Home Loan, the advertised comparison rate is based on a $150,000 loan over a 25 year term so its not going to be accurate for your situation:
- 4 Year intro variable rate (First Home Buyer)
- Interest rate: 3.59%pa (accurate as of 5 July 2019)
- $0 establishment fee
- $0 monthly loan service fee
- Additional fees may apply
- ⛔️ The comparison rate is 4.04%.
Why isn’t it applicable for my situation?
On the website, the comparison rate is being calculated on a $150,000 loan, but you’re wanting a $500,000 loan.
So what you’re seeing – a comparison rate of 4.04% isn’t an accurate example for your loan size.
So in this case, if you’re looking for a higher loan, you’re essentially being misled by what the bank is showing you online.
Next, we need to see what the comparison rate is based on your actual loan size.
Let’s take a look at how the rate differs and the fees affect the overall costs of your home loan for a higher loan.
How can a comparison rate be used?
In a few ways actually.
If you’re applying for a loan, you’ll need to look at all the different variables and features on offer.
And it can be complicated comparing loans that are of different time frames, have different interest rates and fees.
But the good news is, there is where a comparison rate comes in, and how it can be used.
So let’s take a look at an example:
Jill is trying to decide between two different loans. The first (Loan A) is providing an interest rate of 5% with other charges at around 1%. While the second (Loan B) is 5.45% interest rate and 0.5% in other charges.
When we add those two percentages together, this creates a comparison rate.
So for Loan A the comparison rate is 6%, and Loan B the comparison rate is 5.95%.
When we look at these two loans side by side, this now creates a clearer outline of what’s on the table.
We can see that while Loan A provided a better interest rate, the overall cost of B works out a little lower.
And so, in short, that’s how a comparison rate is used.
What comparison rate doesn’t include
Just like many pieces of advice you will be given, a comparison rate is there only to guide you, not to be the final decision point.
Because comparison rates miss out the finer details and every little extra cost.
- ⛔️ It leaves out things like break fees, redraw fees, and late payment fees as well as external charges which can vary between loans.
- ⛔️ Comparison rates also miss out Government fees and any other non-mandatory fees that may be imposed like optional fees for redraw or offset accounts.
- ⛔️ Comparison rates shown are based on a $150,000 loan with a 25-year loan term. If your loan isn’t close to this, then the number you’re seeing isn’t an accurate reflection of your comparison rate.
So to help you overcome this, speak directly to your mortgage broker about how both the comparison rate and other fees that aren’t included in this will affect your loan.
Does the comparison rate make a big difference?
Well see, a comparison rate can help unveil the hidden costs and simplifying decision making by showing a total number, making it easy to compare between two loans.
This means that between two loans with the same interest rate, you can see the variable factors that set them apart.
Really, no two loans are the same.
And a comparison rate kinds of is like the shining light on this.
So yes, a comparison rate is a good starting point to help your decision-making process between two loans on offer.
4. Most Common Comparison Rate Mistakes
As you know, setting up a home loan is about finding the best rate for you.
In fact, according to the Australia Bureau of Statistics, Australia has one of the highest levels of home ownership in the world.
Which means that home loans are in hot demand!
If you don’t do your research properly and use a comparison rate to your advantage, you could be losing money each year on your loan.
And in this chapter, I’ll show you some of the most common comparison rate mistakes, and how to avoid them.
Mistake #1 Relying on a comparison rate ONLY to help you choose a loan
The main mistake I see buyers make before they speak to me directly is relying completely on the comparison rate to do all of the work.
Remember that comparison rates are product specific and do not include the features and other inclusions of a particular loan. This means offset accounts, redraw fees as well as credit card and insurance savings are not included in this number or comparison.
Mistake #2 Not all rates are created equally
Comparison rates don’t look at loans differently.
Which means that fixed rate and variable rate loans are dumped into the same category.
Along with the loan size. Where the comparison rate you’re seeing is only for a $150,000 loan, not your loan size specifically.
This is where problems can occur.
Fixed rate loans can be really misleading because it is assumed that once the fixed period is over, the rate continues as a standard variable rate.
But here’s the catch.
If you’re like most borrowers, once the fixed rate period is over, they refinance.
Refinancing then saves the borrower money because they can get the best available rate, at the time.
…Usually, even lower than the regular one because the lender will offer them a deal.
So comparison rates can’t predict this.
5. Questions you need to ask about your Comparison Rate
Now that your processes are in check, and you know the ins and outs of a comparison rate, it’s time to take things to the next level.
In the last chapter of this guide, we’re going to blast through a handful of questions you need to ask about your comparison rate.
Why is the comparison rate important?
Basically, a comparison rate sets a benchmark for evaluation.
It gets the numbers in line and helps strip back the details of a loan so you can see the difference between a few different loans, side by side.
But as I have said time and time again over the course of this guide, the comparison rate should not be the only factor to consider when applying for a home loan.
How do lenders calculate comparison rates?
Double check that your lender is looking at the following elements to create a formula for your comparison rate:
Interest rate, fees and charges, loan term, payment frequency and loan amount should go into the comparison rate.
When you’re researching and comparing home loans in order to find the best deal for you, the comparison rate will help you figure out the true cost of the loan.
However, it shouldn’t be the only factor you consider.
Compare home loans accurately according to loan type, flexibility, features and inclusions.
This will help you narrow down the right loan types to suit your individual financial needs.
Read More: How to find the Best Home Loan in 2019
6. Now it’s your turn
Do you have any questions about comparison rates?
Or maybe you learned something new?
Let us know in the comments below.
Home Buying Resources:
- The complete guide to the First Home Buyers Grant
- Three big things happening in Brisbane | Property market in 2019?
- 16 Easy Tips to Finding the Best Mortgage Broker in Brisbane