What is the Comparison Rate and Why is it Important?

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What factors do you consider when deciding which loan to use to finance your investments? For the majority of borrowers, the interest rate is the major determinant of whether or not to take a specific loan. One reason for this is that it is the metric provided by lenders as they advertise for loans. With mortgages however, comparing loans goes beyond looking at the interest rate. If you’ve been keen to look at mortgage lenders’ advertisements or have been to see an knowledgeable mortgage broker you have noticed that there’s another figure called the Comparison Rate. Not many borrowers clearly understand the meaning and significance of this metric.

So what is the comparison rate?

The Comparison Rate is a more comprehensive rate used to show the ‘true cost’ of a loan. Why has Australian law required lenders to disclose the comparison rate in their advertisements? Normally, there are other charges and fees that are attached to any kind of loan apart from the interest. These fees affect the total cost of the loan. Comparing each loan’s extra charges can be tedious and ineffective when making financing decisions. The comparison rate aggregates these extra costs into a single metric. Therefore, the law ensures that borrowers have a more comprehensive way of comparing different home loans.

What is included in the calculation of the comparison rate?

When calculating the comparison rate, interest rate and “ascertainable fees and charges” relating to the loan are taken into account. The latter refers to those expenses that are definitely payable during the life of a loan. They include application fees, the cost of valuation, monthly or annual charges, and legal fees. More precisely, the following are used to calculate the comparison rate:

– Loan amount

– Term of the loan

– Repayment frequency

– Interest rate

– Fees and charges connected to the loan

What’s not included?

Some charges depend on the occurrence of a future event during the life of a loan. Such costs are unascertainable and can’t be used to determine the comparison rate. These costs include government and statutory charges, early termination fees, progress payments, costs related to redraw, and charges by other institutions when the borrower decides to switch lenders.

As standard practice, the comparison rate is currently calculated on a fixed set of conditions: a $150,000 loan over a term of 25 years. The way it’s calculated brings us to one major shortcoming. A big number of houses in Australia cost more than $150,000. Therefore, this calculation is just a guide and may not reflect what may apply to your situation.

How does the comparison rate influence your financing decision?

The comparison rate gives you a hint of the amount payable as fees and charges applicable to the loan. A comparison rate that is closer or identical to the actual interest rate indicates that the loan doesn’t have many fees. A significantly higher comparison rate implies a higher amount of fees apply on the loan. So, comparing the comparison rate to the interest rate should form the first point of discussion with a lender.

Other factors to consider when choosing a loan

What really matters when considering a loan is the total amount of money you pay for the loan. The interest rates are just one of the factors affecting the total cost of a particular loan. Always remember that just because the comparison rate and the actual interest rate are low, it doesn’t necessarily mean that you’ll pay less money in the overall. For you to get a clearer and more comprehensive picture of your home loan, research all the features of the loan to determine whether or not it meets your needs.

How can a mortgage broker help you to use the comparison rate effectively?

An accredited mortgage broker can give you a more detailed explanation of comparison rates. The finance professional can also answer all your questions regarding the calculation of the comparison rate based on your specific loan needs. The professionals are also aware of other aspects of home loans that you should know such as loan features and flexibility. Consulting a mortgage broker is a prudent way of avoiding being caught up in the lure of advertised interest and comparison rates.

With a better understanding of comparison rates, you can now calculate the best value home loan on your own using mortgage calculators. You’ve just gained another bit of information to enable you make better decisions when it comes to selecting and applying for a mortgage.

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