Comparison rates help us to compare loan products. They are designed to enable us to compare apples with apples, when it comes to the total cost of lending products, but unfortunately they don’t paint the whole picture.
What is a Comparison Rate?
A comparison rate provides a simplified way to compare the effective cost of a loan product against others in the market.
Introduced to Australia in 2003, comparison rates are required to be displayed by credit providers when advertising fixed term credit for personal domestic or household purposes. That means wherever you see a personal loan or home loan interest rate advertised, you should also find a comparison rate.
Using comparison rates is a more accurate way to compare the effective cost of a loan than interest rates as they take into consideration fees and charges, which interest rates do not. If you were to use interest rates alone to compare loan products it would be akin to comparing apples with pears.
On the surface, two home loan products with the same interest rate may appear to be similar, however when you factor in the fees associated with each, one could work out much more expensive than the other over the life of the loan. This is why comparison rates exist.
Below is an example of how they appear in advertising:
What does a Comparison Rate Include?
A comparison rate factors in:
- The interest rate
- Repayment frequency
- The loan repayment term (i.e. number of years for repayment)
- The main loan fees including establishment fee, annual fee, monthly fees and discharge fee.
Comparison rates also take into consideration the impact of promotional or fixed interest rates on the total cost of the loan. For instance, a promotional or fixed interest rate may appear competitive, but what about the cost of the loan once the period of offer ends and the loan reverts back to a higher rate? Home loans are often provided on 25 to 30 year terms, so whilst a promotional or fixed rates may initially seem attractive, it pays to use the comparison rate to consider the cost over the term of the loan.
Although comparison rates factor in a lot more than advertised interest rates, there are other fees, charges and important loan features that are not used in their calculation.
Limitations of Using a Comparison Rate
Whilst a comparison rate, more accurately reflects the cost of a loan than an advertised interest rate, there are several costs that are not taken into consideration, including the following:
- Government fees
- Lenders’ Mortgage Insurance
- Fees and charges subject to transactions and services
- Lack of access to additional facilities
Government fees such as Stamp Duty and Lenders’ Mortgage Insurance – if required – can add significant cost when taking out a loan. However, for similar loan products, the combined cost of these fees doesn’t typically vary a lot, if at all, between providers.
However, what can differ drastically between loan products and providers are the fees and charges associated with particular transactions or services.
Making a change to a loan product – for instance changing from a fixed term to a variable rate and vice versa – or switching your product type will likely incur additional charges. Making additional repayments to your loan, early repayments in fixed periods or paying out your loan to refinance with another provider could also incur additional charges. These fees are not captured in comparison rates but can usually be found in product disclosure statements or fees and charges documents.
Having access to additional facilities such as offset accounts and redraw can have a positive impact on your ability to reduce the overall cost of your loan. If reducing the interest owed on your loan by making additional repayments is important to you, be aware that not all loan products include an offset account or redraw facility. When they are available, the fees associated with these can vary amongst providers.
Comparison Rates in a Nutshell
Comparison rates are a good starting point to compare the cost of a loan as they take into consideration the interest rate and main on-going and upfront costs associated with a loan product. However, there are other fees, charges and features that impact the effective cost of a loan, none of which are captured in a comparison rate.
Considering this information in addition to a comparison rate will help paint a more complete picture of how loan products stack up against one another.
If you find loan fees, charges and rates confusing, you aren’t alone. Particularly for first timers it can be a daunting task trying to understand what it all means. Just remember, if in doubt ask the loan provider to clarify. After all, being as educated as possible upfront will avoid unwanted surprises later on!