8 September 2021

What’s the difference between interest rates and comparison rates?

By: Shaun Lordan, Chief Product Officer

whats-the-difference-between-interest-rates-and-comparison-rates

To help you get the most out of your home loan and smash your financial goals, let’s answer one of the most commonly asked questions: What is the difference between the interest rate and the comparison rate?   

If you’re shopping around for a home loan or are looking to refinance your existing loan,  understanding the overall cost of your loan is critical to ensure you can afford it and are getting the best deal. Comparison rates can help make this vital decision. 

Research1 shows that 10% of Australian’s don’t know their current interest rate. Despite the fact that 41% of Australian’s say they consider the comparison rate when making a decision, 73% still said the process was confusing. Often, home buyers are missing the best value because they don’t know to true cost of their loan.  

At Nano, we’re all about simplifying the home loan journey. Let’s take a look at the difference between interest rates and comparison rates and why they’re important to help you get the most out of your home loan.  

What are interest rates? 

In simple terms, an interest rate is the amount a lender charges you and is typically an annual percentage  of the amount you borrow. Interest is essentially the  cost to you for borrowing the money. Interest rates can differ for products based on many factors, but most typically they vary as a result of the loan purpose, your Loan-to-Value Ratio (LVR), amount of the loan and repayment type. 

For example, if your loan is $500,000, with a term of 25 years and the interest rate is 2.75% p.a. and you repay monthly, you will be charged interest of around $13,573 in the first year of the loan] on top of your principal repayments of around $14,106. Our online home loan calculator is a simple way to work out your potential repayments and figure out what you could potentially save.  

What are comparison rates? 

From 2003, it became mandatory for lenders to publish comparison rates to prevent the common practice of advertising very low interest rates and stinging unsuspecting borrowers with other hidden fees or higher rates after honeymoon periods. Ouch! 

The comparison rate includes the known interest rate at the start of the loan and ongoing throughout the life of the loan, as well as additional fees like account keeping fees and rate lock fees that some lenders charge. The total figure is converted into a percentage that gives you a clearer picture of the true cost of the loan. Put simply, the comparison rate allows you to compare apples with apples when it comes to home loans.  

At Nano, we believe in being fair and transparent. That’s why we charge no fees. 2 That means our comparison rates for our home loans are exactly the same or lower than our headline interest rates—seriously. You’ll also be happy to know that Nano has some of the lowest comparison rates in the Australian market.  

What’s the difference between the interest rate and the comparison rate? 

While the interest rate simply represents the initial interest you will be charged on your home loan, the comparison rate combines the initial and ongoing interest rate and most of the other fees that some lenders may bundle into the loan (more on this below).  

How the comparison rate is usually calculated 

For home loans, the comparison rate is generally calculated on a $150,000 loan, over a 25-year loan term. The comparison rate takes into account interest rates, repayment frequency and other fees and charges like annual fees. Based on this, you will be given a percentage rate that’s much closer to the true cost of your home loan. 

If you’re wondering what fees you need to consider when assessing the true cost of your home loan, let’s take a closer look. Note: Some fees are charged by 3rd parties and government, others are charged by the lenders themselves. 

Types of FeesSome LendersNano
 
Upfront Fees   
Application fee ✔️ ❌ 
Pre-approval fee ✔️ ❌ 
Valuation fee ✔️ ❌ 
Documentation preparation fee ✔️ ❌ 
Legal fee ✔️ ❌ 
Settlement fee ✔️ ❌ 
   
Ongoing Fees   
Monthly account fees ✔️ ❌ 
Annual package fee ✔️ ❌ 
Periodical admin fee ✔️ ❌ 
   
Discharge fees   
Discharge admin fee ✔️ ❌ 
Documentation preparation fee ✔️ ❌ 
Settlement fee ✔️ ❌ 

*This is not an exhaustive list of fees  

How and where to find the comparison rate  

Lenders are legally required to show the comparison rate alongside the advertised interest rate. Lenders are also required to include a comparison rate warning. It’s helpful to look for a key facts sheet like the one we provide. This is where lenders will provide information about a loan’s comparison rate, interest rate and other useful facts and supply you with a standard document that you can use to compare all lenders.   

Comparison rates are shown when a home loan is being advertised so you will generally only see the comparison rate for a home loan product at the start of your home loan journey. Once you’re a customer, your documents will only show the interest rate, which can give you a false sense of your financial situation, or worse, an inability to see what you are really paying on the loan. So, it’s important to pay attention to, and be comfortable with the comparison rate when you start your refinancing journey. 

Why the comparison rate is important 

Put simply, if paying down your home loan faster is a priority for you, then the comparison rate is your best friend. The comparison rate helps you compare multiple home loans and reveal the real difference in cost, regardless of the seemingly appealing interest rates.  

For example, let’s say you want to take out a loan of $500,000, over 25 years and are comparing two home loans. Loan A has an advertised interest rate of 2.5%p.a. and a comparison rate of 3.5% p.a., while Loan B has an advertised interest rate of 2.9%p.a. and a comparison rate of 3%p.a.. You might be tempted to go for Loan A purely based on the lower interest rate, however, Loan B could save you up to $39,000 over the lifetime of the loan. Now just think about what you could do with that extra cash

Get the full picture 

When comparison rates were introduced in July 2003, they were calculated based on an example loan of $150,000, a loan period of 25 years and a principal plus interest loan. That formula is still used today, although the home loan market now looks very different.  

The average home loan is now over $500,000 and the average loan term for the majority of borrowers now also exceeds 25 years. Changing the terms or length of a loan can also significantly impact the loan’s comparison rate. Advertised comparison rates may not give a full picture of the cost of your loan but they are still a really useful estimate of the true cost of a loan for you to consider. Remember, the advertised interest rate is not always what it seems. 

Your home loan comparison checklist 

Keep these things in mind when shopping around for the best home loan: 

  1. Ask to see lenders’ comparison rates if they are not clearly advertised and don’t be afraid to ask what is and isn’t included in a lenders comparison rate. 
  2. Make sure you compare the interest rates and comparison rates of different lenders to get the best possible deal. 
  3. Look for lenders like Nano that charge no fees and offer comparison rates the same or lower than their advertised interest rates. 
  4. Be cautious of home loans with “honeymoon periods” that offer low rates at the start of the loan; these can end up costing you more in the long run as the rate increases over time. 

Helping you understand your home loan  

Finding a home loan with the best interest rates and lowest fees can feel like hard work, but understanding the difference between interest rates and comparison rates is a great first step. With a clearer picture of the cost of your loan and how long it will take you to pay off, you can plan for the future and reach your goals sooner. At Nano, we believe home loans can be simple, fast and fair.  Check out our website today to find out how we can help you on your home loan journey. 

Sources:  
1. Pure Profile Research, March 2021 based on a sample size of 1000 people aged 18+.  
2. Government charges will still apply.