Comparison rates have been required to be included when advertising lending interest rates in Australia for many years now, but there is still some confusion around what they are and how they can help you when deciding on your next loan.
Comparison rates have been designed to give a snapshot of the loan on offer once certain prescribed fees are included so that the consumer can compare ‘apples with apples’. They calculate the interest rate over a set period of time while also including fees which are reasonably ascertainable (i.e. it is almost certain that the particular fee will be payable). Examples of fees included in the calculation of the comparison rate are the establishment fee, annual home loan package fee or account maintenance fees.
Comparison rates are a particularly valuable tool when comparing variable interest rates and fixed term loans whereby the fixed term is the same as the loan term. This is common amongst personal and car loans. Home loans however, rarely will fit into this category as the fixed term is usually between one to five years over a loan term of up to 30 years.
When calculating a comparison rate credit providers take into account the introductory rate, loan term and the variable interest rate that the loan will revert to for the remainder of the term of the loan. This in itself may be confusing as it is assumed that for the remainder of the term of the loan you will leave it at that rate and not choose to fix your interest rate again.
It is detailed clearer in the table below:
| LOAN 1 | LOAN 2 | LOAN 3 | |
| LOAN AMOUNT | $150,000 | $150,000 | $150,000 |
| TERM (YEARS) | 25 | 25 | 25 |
| INTRODUCTORY TERM (MONTHS) | 24 | 24 | 24 |
| INTRODUCTORY INTEREST RATE (example only) | 3.89% p.a | 3.99% p.a. | 4.09% p.a. |
|
STANDARD INTEREST RATE |
4.99% p.a. | 4.64% p.a. | 4.94% p.a. |
| ESTABLISHMENT FEE | $500 | $500 | $500 |
| ANNUAL FEE | $350 | $350 | $350 |
| COMPARISON RATE | 5.14% p.a. | 5.14% p.a. | 5.14% p.a. |
| This table is an example only. |
In the above table, all of the loans are the same amount, term and have the same fees. The only changes are to the interest rates. It is interesting to see how greatly the standard interest rate affects the comparison rate. This is because it is calculating the introductory rate over two years (in this example) and the standard interest rate over the remaining 23 years.
Although Loan 1 offers the lowest fixed interest rate, the lowest comparison rate is on Loan 2. Also of note is that although Loans 1 and 3 have quite different interest rates,they have the same comparison rate.
If you are planning to only fix your loan for the initial term then let the loan sit at the standard variable rate for the remainder of the term then the comparison rate will give a true comparison.
However, if you plan to review your loan after the fixed term ends, it will pay for you to do your own investigation into the real cost of the loan and fees as you may find the comparison rate does not reflect the true cost of the loan.
If you are interested in discussing loan options, please contact one of our friendly team today.