Over the past few years, housing affordability and soaring interest rates have been a popular topic of discussion. In the latest federal budget, the government has extended first home buyer support in an attempt to make the housing market more affordable by offering larger loans, allowing smaller deposits and slashing variable home loan interest rates.
There is a lot that first home buyers should know, but the most common concern is about whether or not interest rates truly reflect the actual cost of their monthly or annual mortgage repayments.This very question is the reason why comparison rates exist, why they are legally-mandated and why they are so important.
Comparison rates consider not only the interest rate, but any additional ongoing fees and charges which will end up elevating the interest rates and costing the lender more money. As such, a comparison rate gives you a more accurate indication of the actual value of your home loan and how much it will cost you per year. Before locking yourself into a mortgage, it is important to understand the true cost of the long-term debt you are signing up for, and to do this, you must take into account the comparison rate.
Comparison Rate Meaning
Comparison rates were introduced to protect consumers and borrowers from falling victim to hiked up interest rates and hidden costs. Before comparison rates, hidden costs and fees could inflate an interest rate and cause extra expenses that consumers could not afford. This is because interest rates reflect the amount of interest a home owner will pay per annum, however they do not take into account the associated fee, upfront costs, government fees and redraw fees that may be involved with a loan.
ASIC has since stepped in with the National Credit Code to make advertised comparison rates mandatory. With interest rates set to rise again this year, it is essential that first time home buyers know exactly what deal they are getting and are comfortable that they will be able to make the repayments.
Every credit provider is legally required to advertise not only the interest rates, but the comparison rates also. What is most telling is that the interest rates are normally advertised in large font, while the comparison rates are usually smaller. This is because the comparison rate is usually substantially higher (which is less appealing to borrowers), but more indicative of what you will actually be paying per year.
Why is it Important?
If a home loan interest rate looks too good to be true, it very well might be.
Comparison rates are important because they provide an accurate and transparent indication of what repayments will actually cost each year. The law dictates that all money lenders must display a comparison rate next to home loan interest rates as they often can be different. Unlike a home loan interest rate, which only determines how much interest you will be charged per year on your home loan, a comparison rate aims to help you better understand the overall cost of the loan per year, taking into account fees and other costs that home buyers need to know.
Comparison Rate vs Interest Rate
It is fairly clear at this point that interest rates and comparison rates will almost always be different, but the most important for potential lenders to identify is how different they actually are. A home loan's comparison rate will include fees and charges that your mortgage broker will expect to be paid, whether you were aware of them or not. It is all in the fine print and despite your own personal circumstances
Interest rates can either have fixed rates or they can have a variable rate. The difference between the two is that a variable interest rate has flexible features like the ability to make extra payments, offset accounts and redraw facility, while fixed rates, as the name suggests, are less flexible.
How to Calculate Comparison Rate
A comparison rate is calculated in terms of industry regulations:
- A loan amount of $150,000.
- A loan term of 25 years.
- The repayment frequency (usually monthly).
- The interest rate, including known changes to the interest rate such as introductory rates, interest-only periods and loyalty bonuses.
- Fees and charges associated with the loan such as establishment fees, annual fees, monthly fees, a valuation fee, mortgage documentation fees, settlement fees and a discharge fee, plus any other ongoing costs or additional fees that are relevant to the particular loan.
As you can see, there is a lot more to contend with than just the interest rate. When comparing any finance offers you need to know all the fees and charges you are currently paying or will be charged. If an offer has the same advertised rate and comparison rate, then you know you won’t be slapped with hidden fees or charges.
What isn't Included in a Comparison Rate?
While comparison rates are useful for getting an idea of what the costs will be, there are factors that a comparison rate does not include. Basically, comparison rates do not include costs that are deemed non-mandatory or that you accrue separately. As such, comparison rates do not include the following:
- Government charges such as mortgage registrations fees or stamp duty,
- Conveyancing fees.
- Fee waivers or interest offset arrangements.
- Early termination fees, break costs or deferred establishment fees.
- Fees and charges that are not applicable at the time that the comparison rates are calculated, as well as fees which are not utilised by the borrower (redraw fees or early repayment fees).
Be sure to read the relevant product disclosure statement (PDS) which includes key information regarding the features fees, commissions and risks of the financial product. All appointed credit representatives are required by law to provide a PDS. It is important that you factor these costs into your decision-making when determining your lending criteria. Everyone has their own circumstances and personal objectives, and should be looking for the best loan they can get while ensuring they stay within their budget.
Comparison Rate Example
It is essential that you compare home loans and investigate the advertised interest rate with scepticism. Unfortunately, it is in the bank's best interest to lock you into a high interest mortgage with many fees and hidden costs. This is why you must compare and contrast the advertised interest rates against the home loan companions rate to determine the difference.
Comparison rates and the way in which they differ to advertised interest rates is relatively simple to understand. For example, if a lender advertised a home loan interest rate of 2.7%, but there was an annual fee, ongoing costs and charges which equalled 0.3%, then the comparison rate would be 3% in total.
This is why the comparison rate is so essential, because it can enable consumers to find the best deal for their specific circumstances and financial situation. The cost of a loan should not break your back, which is why you should always check a comparison website which shows the offers from multiple lenders before deciding on a fixed rate for a loan.
Why is the Comparison Rate Higher?
The simple explanation for a comparison rate being higher than an interest rate is because it includes the interest rate plus extra fees. For instance, fees that might be included in a comparison rate that are not necessarily included in an interest rate include monthly account fees, annual fees, establishment fees, settlement fees and any other fees that are attributed to the home loan.
Australia boasts the "big four" banks: Commonwealth Bank, National Australia Bank, ANZ and Westpac. The big four have recently slashed their variable mortgage rates ahead of expected Federal Reserve interest rate hikes in June 2022, with small banks also offering competitive interest rates to reel in customers. Thanks to the internet and regulations by ASIC, comparison rates are now right next to interest rates on comparison websites.
For instance, at the time of this article, Commonwealth Bank's fixed home loan package has an interest rate of 3.49% and a comparison rate of 4.67%. NAB is offering a fixed rate home loan of 3.59% and a comparison rate of 4.74%, ANZ is offering 3.64% and a comparison rate of 3.77%, and Westpac is offering 2.29% with a comparison rate of 2.30%. Of course, these rates are always subject to change, but it is interesting to see how the interest rates and comparison rates differ across the most competitive banks in Australia.
How Do I Find a Comparison Rate for my Home Loan?
It can feel overwhelming trying to get to the bottom of how much a home loan will actually cost, especially when taking fees into consideration. Fortunately, Joust has revolutionised the way Aussies access a better home loan by giving the power back to you.
Joust removes any confusion for customers by requiring lenders to submit comparison rates when bidding for your home loan, which means you do not need to seek independent advice to find the best interest rate bid.
Want to learn more about how Joust works? Click here to find out.