Banks and other financial institutions are required by law to disclose the comparison rate when they advertise an interest rate of a loan. But when it comes to the mortgage market, borrowers often misunderstand the concept of this rate. Therefore, it is crucial to know what comparison rate is and how it can prove to be of use in getting a better deal.
What is a Comparison Rate?
The comparison rate or mortgage comparison rate is a tool to help represents the rate of interest and all other loan charges and fees. It combines all of these costs in the form of a percentage. The rate actually depicts the true cost of a loan.
Companies, financial institutions, and individuals use an interest rate of a loan to compare different loans. Although, it provides a good base for comparison, yet it does not take into account everything.
For example, it does not represent the payment terms, upfront or on-going fee, establishment fee, approval fee for a loan, or any other associated cost.
On the other hand, comparison rate consists of the following:
• Loan amount
• Repayment frequency
• Loan terms
• Interest rate of a loan
• Fee and other charges
This rate is an effective tool for borrowers and financial institutions to compare different loans. It gives a good estimate of the overall cost associated with the loan. However, comparison rate is only one feature of the loan. A person must take into consideration all other features based on his or her financial preferences when applying for a loan.
How Can a Comparison Rate be Used?
Whenever you apply for a loan, you must compare all of its features. A small variation in the rate of interest can make a huge difference in your payments over a period of time. It is not easy to compare home loans that have different terms, interest rates and charges. This is the reason why lenders are under obligation to provide a comparison rate when advertising a weekly loan payment or interest rate.
For example, a person has to choose between two different home loans. The interest rate and other charges of the Loan Y are 6% and 1% respectively. Whereas, the interest rate of Loan Z is 6.25% and other charges are 0.1%. This means the comparison rate of Loan Y is 7% and it is 6.35% for Loan Z. Although, Loan Y offers a lower rate of interest, yet the overall cost of Loan Z is much lower as represented by the comparison rate.
How Important is the Comparison Rate when Choosing a Home Loan?
The comparison rate provides a great basis for comparison. However, it gets difficult for a person to decide whether he should select a variable rate or a fixed rate, keeping in mind the important features of the package. Therefore, comparison rate should not be the only factor to consider when applying for a home loan. A person must consider other features as well. Some of these features are as follows:
• Redraw Facility – If a loan offers re-draw facility, you would probably choose it despite the high 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. In the above example, a person may choose Loan Y 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 better and in-depth understanding of what comparison rate is, consult Hunter Galloway’s 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.