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These lenders will undoubtedly include banks, credit unions, building societies and specialist lenders, who are required by law to advertise two sets of rates: the interest rate and the comparison rate. If you’re starting the process on your own and don’t have a broker yet, it can be tough to make sense of the different rates and what they mean.
Interest rate
In simple terms, the interest rate is the rate that you’ll pay above and beyond the amount of your home loan as a fee to your lender for borrowing the money. It is the percentage of the loan that you will pay per year based on your yearly balance, and this is most important when it comes to your monthly payment amounts – or periodic payments, if you decide to pay more often. The easiest way to work out your repayments is to use an online home loan calculator.
Comparison rate
According to the National Credit Code (NCC), “[t]he comparison rate regime aims to inform consumers of the true cost of credit that applies to a specific credit product and make it easier for consumers to compare the different credit products available on the market.”
As part of the NCC, credit providers are required to include a comparison rate when they advertise certain types of fixed-term credit. This comparison rate includes the actual interest rate, was well as most – but not all – fees and charges involved in servicing the loan. Government fees and charges aren’t included, nor are charges that only apply in certain circumstances, such as early repayment of the loan if not permitted or other penalties.
“Comparison rates can be hugely misleading as they are based on a moment in time - fixed rate at 3.5 per cent followed by a variable rate of 4.5 per cent may have a comparison rate of 4.255 but in reality at the end of the fixed period the borrower can shop around again,” says Declan Murphy, managing director at QuickSelect.
The comparison rate only allows comparison based on cost, and will not include other factors that may make a loan more attractive to borrowers, such as access to fee free accounts or flexible repayment schedules.
“The comparison rate also has no way of reflecting a lenders history and whether they increase rates out of cycle or move you to a different product,” Murphy says.
Does this actually help consumers?
The idea of the rate, then, is for consumers to be able to look at home loan products and see what they’re going to end up paying. On the face of it, that’s advantageous. Of course you want to know what your initial loan is really going to cost you at the end of the day. Many consumers, however, aren’t reaping the benefits.
A recent national mortgage survey revealed that almost half of Australians misunderstood what was meant by a comparison rate and a further 28 per cent said that they didn’t know what was a comparison rate actually was. The results of the survey, commissioned by Credit Union Australia (CUA), indicate that the goal of informing customers is actually ineffective, and “the vast majority of home buyers and those looking to refinance their home loan could be missing out on the best value loans because they don’t know how to compare the true cost of different loans.”
“As a responsible lender, we have a duty to make sure borrowers understand the tools they have at their disposal to find a home loan that best suits their situation,” Andy Rigg, CUA chief operating officer member services, said in the report. “Property buyers need to be careful that what looks like a very low rate doesn’t actually have lots of nasty hidden fees and charges.”
But even when consumers do know what information the comparison rate intends to offer, it’s often overlooked that the comparison rate is based on a set parameters that may not apply to the loan being considered. The weighted average median house price for the eight capital cities in the September quarter of 2016 was $712,776, according to the Real Estate Institute of Australia (REIA) – so even with a significant down payment, the home loan required for many buyers is a far cry from the loan amount that the comparison rate typically uses, which is only $150,000.
What’s more useful?
When it comes to whether or not the interest rate or the ‘true interest rate’, as the comparison rate is sometimes called, is more useful, it depends on what information you’re looking for.
So while you may be able to compare the two loans against each other, neither is going to be able to accurately tell you the full amount you’ll pay over the life of your loan if you have a loan with an amortization period other than 25 years or a loan amount other than $150,000. If you’re looking at two loans side by side, you can use the comparison rate alone to see the percentage of the loan amount that you’ll end up paying in the end, which is useful information. You can also use the interest rate alone to see what your monthly payments will be, which is also useful information. From there, however, you’ll have to do the math yourself or use a mortgage comparison calculator to figure out what the actual cost for your particular loan will be.
What’s a borrower to do?
It’s always a good idea to start doing research on your own, but don’t assume that one loan will be better than the other based on the rates alone. Brokers will help borrowers to understand the difference between the two types of rates and decide which loan is the best fit for your personal situation – rates and all.
“Generally we go through the subtleties but get borrowers to understand that we review their situation annually so that we are looking at things in real time,” Murphy says.
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