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How much do you really know about your home loan?
Mark Bouris explains:
There’s something of a home loan ‘rate war’ going on at the moment, which can be great for borrowers. But it also creates pitfalls for the unwary.
Take some mortgage advertising I saw this week: it promoted a variable mortgage rate of 4.65 per cent but beside it was a ‘5.21% comparison rate’.
Look at the difference: on a $300,000 25-year mortgage at 4.65 per cent your total interest bill is $207,941. But if you pay 5.21 per cent, your costs total $237,198. The difference between what’s calculated from the headline offer and the actual costs over the long term is around $30,000.
This type of advertising is a common marketing device. The low interest rate is merely an ‘introductory rate’ which in this case lasts three years. And after three years the home loan reverts to a much higher rate.
So given the current interest rate cycle it’s a good time to discuss the comparison rate. The ‘comparison rate’ is a legislated requirement brought in by the federal government. It was introduced in 2003 at a time when ‘honeymoon rates’ were popular and advertised interest rates were not informing borrowers about the true long term cost of their home loan.
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It’s quite difficult for average borrowers to calculate what they really pay over the long term if they pay one rate for, say, two years and then revert to a ‘true’ rate for the next 23 years.
So to resolve the confusion the government mandated a formula that all mortgage lenders must use in their advertising. It includes unavoidable fees and charges, and interest rates over a set period, which creates the comparison interest rate.
Because all lenders have to use the same formula, the result gives a borrower the means to compare the true cost of a loan before they commit to it, and it gives some reality to the headline interest rate.
This regulation set by the government is important, but it only goes so far. The key to getting the right loan is for you as a consumer to take this information and act on it. The law says that a comparison rate must be co-located with the promotional rate, and with the same prominence. But a comparison rate is useless unless borrowers are looking at it and registering what it means. In talking to people, I often find that consumers misinterpret the comparison rate as “X” lenders best rate compared to “Y” lenders best rate. This is not at all the case.
When you look down the most affordable variable rate loans on a site such as RateCity, you see that those lenders with the best ranking have comparison rates almost identical to their advertised rates – that is, the rate they advertise is basically what the borrower will pay. But other loans only start at 4.6 per cent, before reverting to something much higher.
Consumers are easily confused by the terminology and practices of the financial services industry. So if you’re searching for something as important as a mortgage, and a comparison rate gives you a chance to level the playing field, you really must pay attention.