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What is the comparison rate?

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Understanding what a comparison rate is, is an important factor in making good borrowing decisions. Here is everything you need to know about comparison rates.

The mortgage market is very large and competitive in Australia. So lenders position themselves with marketing, much of which is based on interest rates. Often, what is being offered is a home loan with a ‘discount’ rate or an introductory rate, either of which are interest rates lower than the rest of the market.

The discount rate is when a lender tells you that they will discount their standard variable rate by a certain amount – usually enough to get your attention. This looks like a good deal, although the original rate may have been higher than the market average, and the rate may only last a year. The introductory rate is similar: it is a very low interest rate designed to catch your eye and attract your business, however the loan probably reverts to a much higher rate in 1 – 3 years.

In both of these cases, the special offers reduce your mortgage repayments for a certain time, but it is very hard to properly calculate what your actual interest rate is over the full term of the loan.

Therefore the federal government has a legal formula that all mortgage lenders must use in their marketing and information documents. This formula is called the Comparison Rate and it requires the lender to state a ‘real’ interest rate over the full term of the loan, which includes ascertainable fees and charges, and also allows for the introductory or discount rate. This comparison rate has to be included in marketing material, at the same size  and prominence as the special offer. The comparison rate is not perfect – it’s formula is based on a 25-year, $150,000 loan, so it was obviously formulated a number of years ago

Take the first step

However, while an introductory rate catches your eye, the comparison rate tells you the actual rate you will pay. In the case of a discount rate, the advertiser can claim a ‘1.25% discount’ on their normal interest rate, but they don’t have to publish a comparison rate to this offer.

Sometimes the difference between the special rate and the comparison rate is negligible because the lender is really marketing their best rate, which is the comparison rate. But other times the difference between the special offer and comparison rate is significant.

The comparison rate is a feature tool designed to protects the borrower, but like all types of information, it has to be acted upon for it to be of any use. If you see a very low special offer, with a relatively high comparison rate beside it, you should ask the lender about this deal and why the discrepancy is so large.

The comparison rate is an important information source when you’re looking for the best mortgage: it may not be as attractive as the special offer but it is the actual rate you’ll be paying.

The comparison rate is important for borrowers, but don’t let it obscure other factors you should be looking for in a home loan. For many home buyers, the loan features and loan-type are just as important as the interest rat

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