What Are 'Home Loan Comparison Rates'?

Friday, March 21, 2014

Comparison Rates as 'all things considered'

All banks, lenders and similar institutions are required by law to provide ‘comparison rates’ for their loans – but what are comparison rates exactly, and how do they work?

In short, a comparison rate is a number designed to showcase the total cost of a loan (as opposed to just the cost of a loan’s interest, or somehow a competitor's interest rate average - I can confirm, after my own misconceptions, that it is neither of those things).

Typically, a comparison rate percentage will have incorporated the amount of a loan, the term of the loan, the repayment frequency, the interest rate and the fees and charges associated with that particular loan in order to arrive at its sum.

As their name suggests, these percentages are designed to allow you to better compare different home loans.

By way of demonstration; you may find two loans offering competitive interest rates – 4.25% and 4.95%, for example – and be tempted to take the lower offer. However, because of additional costs, your 4.25% loan might actually end up being more expensive. Comparison rates allow you to factor in those additional costs when selecting a home loan. In our example, your 4.25% loan could have a comparison rate of 6.5% – while your 4.95% might be 6.25%.

All that said, it’s important to remember that conventional wisdom says to not rely exclusively on comparison rates when choosing a home loan. As home loans have grown more complex and customisable over the years, comparison rates have grown a little less reliable – in that, there can be costs outside of what a comparison rate is designed to consider. Something like a home loan package, for example, is a little too complicated to be judged by comparison rate alone.

They’re best viewed as a part of a larger process of evaluation. After you’ve considered some comparison rates for loans, you should speak to your bank or lender in-depth about each prospective loan as it relates to your specific situation and tease out each cost in detail. Remember, every home loan is different. It may seem like an arduous approach – but it will save you money longterm, I promise.