Dear Aunt Sue – I am thinking about buying my first home and looking at different banks. What does it mean when they display a ‘Comparison rate’? Sonia – Newport
Hello Sonia.
Fantastic that you are looking at purchasing your first house. Good on you!! There certainly is a lot of talk around at the moment by both State and Federal Government about helping first home buyers get into their first home. I hope you will be able to benefit from some of the initiatives being mooted about.
But back on to comparison rates.
As a legal requirement, banks and lenders must display a comparison rate when advertising a loan. But what is a comparison rate? It’s a rate that considers the fees and charges of a loan to give you the most accurate interest rate once everything has been taken into account. Comparison rates have become a legal requirement in order to stop lenders from advertising ridiculously low-interest rates that tricked unsuspecting customers into loans that actually ended costing them a whole lot more than they initially signed up for.
Comparison rates can get a little confusing, but it is only there for you to be able to identify the true cost of the loan. By only looking at the advertised rate, you might miss the fact that establishment fees, approval fees, and all other upfront or ongoing costs come along with that rate.
For example: most lenders will advertise their interest rate in bold, let’s say its 5.5%, but if you look a little closer, you should be able to see a comparison rate (written in smaller text) that is inclusive of additional charges – this could be, perhaps, about 6.75%. The comparison rate will give you a much better insight into how much the loan will actually cost.
By showing a cheaper interest rate in bigger font, it will catch your eye and make you think that you’re getting a great rate but when you look closer you will always see the comparison rate which gives you a clearer indication of how much you will actually pay.
A comparison rate typically compromises the following calculations:
- The cost of the loan
- The duration of the loan
- How often you should make repayments
- The interest rate;
- As well as, all fees and charges associated with the loan
A comparison rate is probably one of the most useful tools every borrower should know about. Without this rate, you won’t be able to truly compare the costs of different loans. Although, it’s important to note that the comparison rate isn’t the be all and end all of loans.
For example, with variable interest rates, you might find one advertised as 5.50% with a comparison rate of 6.25% based on a loan of $200,000 over 30 years. This comparison rate reflects an accurate cost of this example loan but it would be completely different if the loan was doubled or over a shorter/longer term. In order to get the most precise rate for your loan, you need to look at, not only the comparison rate, but also the term closest to the cost and duration of your loan.
If you are still a bit confused by all of this, then I would recommend speaking to your bank, financial advisory team, or even your local mortgage broker. They will be able to explain exactly how the comparison rate affects your loan repayments. It can get a little confusing but it is absolutely essential that you are 100% aware of the loan that you are entering into and what it means.
So until next time girls and boys, as always keep those questions coming in by visiting our Contact Us page.
And a funny story I found that you will hopefully get a laugh from:
A client bought a new home and the broker wanted to send flowers for the occasion.
They arrived at the home and the owner read the card; it said: “Rest in Peace”.
The owner was angry and called the florist to complain.
After he told the florist of the obvious mistake and described how angry he was, the florist said, “Sir, I’m really sorry for the mistake, but rather than getting angry you should imagine this: Somewhere there is a funeral taking place today, and they have flowers with a note saying, “Congratulations on your new home”.
Have fun and keep smiling – Aunt Sue
