Comparison Rates

Comparison Rates

What is a Comparison Rate?
A comparison rate is a tool to help consumers identify the true cost of a loan.

It is a rate which includes both the interest rate and fees and charges relating to a loan, reduced to a single percentage figure. For example, a bank's advertised interest rate may be 7.12% and its comparison rate 7.45%.

What does that mean in Simple Terms?
The easiest way to explain comparison rates is to give an example:

Loan Amt Rate Fees/Yr Interest
$10,000 10% nil $1,000
$10,000 11% nil $1,100
$10,000 10% $100 $1,100

In the third example above the quoted interest rate is 10% which attracts $1,000 in interest per year.  The fees are $100 per year.  This means a total payment of interest AND fees of $1,100 per year, which is the equivalent of paying 11% interest.

Therefore, in the third example above, the interest rate is 10% while the comparison rate is 11%.

Comparison Rates Can be Misleading
A Comparison Rate can be useful in determining is one loan has more fees and charges than a similar loan.  However, the issue with Comparison Rates is that they assume that the loan will run for it's full term.

Take the following example:

Application Fee Yearly Fee Total Fees - 30 yrs
$600 nil $600
nil $100 $3,000

Assuming Interest Rates are the same, the first loan looks more attractive as it has less fees over the life of the loan.  However, most loans don't last the full 30 years.  In the above example, if you kept the loan for less than six years the second loan would look more attractive than the first loan.

Comparison Rates do not include early termination fees that may be included with the loan as it is assumed you will be keeping the loan for the full 30 years.

Why is a Loan Amount always quoted with a Comparison rate?
A Comparison Rate is only valid for the loan amount quoted.  The higher the loan amount the less significant the fees and charges become.

Loan Amt Rate Fees/Yr Comparison Rate
$10,000 10% $100 11%
$100,000 10% $100 10.1%

So are Comparison Rates Useful
Yes, Comparison Rates can be useful in determining which loan is right for you.  However, you should also ask your mortgage broker to explain how you will be impacted if you keep the loan for less than the full term

See Real Estate Australia & Home Loans for some more information on this topic

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