Interest Rates vs. Comparison Rates: What Is the Difference?
Get to know the differences between interest rates and comparison rates and make a smarter choice about your home loan.
When it comes to getting a home loan, you’ll be faced with a whole host of terms and rates. Two of the most crucial are ‘interest rate’ and ‘comparison rate’.
While these phrases might sound somewhat similar, understanding the differences between the two can make a big difference to the overall cost of your home loan.
What is an interest rate?
Let’s explore what we mean when we say, ‘interest rate’.
The interest rate is the cost you pay each year to borrow money. This is expressed as a percentage of the loan amount.
An interest rate is the most basic cost associated with your home loan and will determine the principal amount of interest you’ll pay each year. This rate is a key factor in calculating your regular loan repayments.
What is a comparison rate?
The comparison rate, on the other hand, is a more inclusive rate that reflects the true overall cost of the loan. It includes the interest rate, plus most of the fees and charges associated with the loan - like application fees, ongoing account-keeping fees, and any other charges.
Like the interest rate, the comparison rate is expressed as a percentage of the loan amount but is designed to give you a more accurate idea of the true cost of the loan. For example, your home loan might have an interest rate of 3%, but a comparison rate of 3.5% once fees and other costs have been included.
Why It’s Important to Know the Difference
- Understanding the actual loan cost: The interest rate doesn't tell the whole story about what you’ll pay. The comparison rate, however, includes both the interest rate and fees, giving you a more accurate picture of the loan's total cost.
- Comparing loans: When shopping for a home loan, comparing just the interest rates might lead you to believe one loan is cheaper than another, when in fact, extra fees could make it more expensive. The comparison rate is a better tool for comparing the real costs of different loans.
- Avoiding financial surprises: By looking at the comparison rate, you can avoid unexpected expenses, ensuring that you’re fully aware of all costs associated with the loan.
Factors That Influence Comparison Rates
- Loan amount and term: The comparison rate can vary depending on the loan amount and the term. For example, a comparison rate calculated for a $250,000 loan over 25years might be different from a rate for a $500,000 loan over 30 years.
- Fees and charges: Application fees, monthly or annual service fees, and other loan-related charges are included in the comparison rate calculation.
- Frequency of repayments: How often you make repayments can affect the total amount of interest paid, which can influence the comparison rate.
The Limitations of Comparison Rates
While comparison rates are useful, they have certain drawbacks:
- They don’t include personalised costs: Comparison rates don't consider some additional costs, like early repayment fees or redraw fees.
- They might not include all costs: Some charges, like government fees related to loan features, aren’t included in the comparison rate.
Tips When Considering Home Loan Rates
- Consider both the interest and comparison rates: It’s important to pay attention to both rates when you’re evaluating your loan options.
- Ask questions: If in doubt, ask your lender or financial advisor to explain how the comparison rate is calculated and what costs it includes.
- Look beyond the rates: While rates are important, also consider loan features and flexibility that suit your personal and financial situation.
Understanding the differences between the interest rate and the comparison rate of a home loan can give you an advantage in selecting the best loan for your needs. It’s also important to be aware of the limitations of these rates, as well as how they might affect your personal situation.
Remember, the more you know about what’s involved in your home loan, the better equipped you’ll be to make the best decision!
This article is intended to provide general information only.It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Please consider seeking financial advice before making any decision based on this information.
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