Understanding the impact of home loan interest rates

We all understand the importance of finding a lender offering competitive interest rates when entering into a home loan however there are other factors you need to consider including, comparison rates, fees and charges.

While it’s not the only thing you want to think about for your home loan, it’s natural and important that you compare interest rates between the different home loan options you’re considering. Remember that interest will be the biggest single cost you face – a $400,000 home loan with a 6.5 percent interest rate will cost you over $400,000 in interest over 25 years!

When you compare interest rates on home loans, you will generally see two rates. The first is the “headline” or advertised rate. Most lenders advertise this rate, and it’s the one that you’ll pay on your debt on day one. But it’s not sufficient to fully understand the cost of the loan.

That’s why there is a second, and perhaps more important interest rate you need to look at, called the comparison rate.

What is a comparison rate?

In order to compare interest rates and fees, the government developed the concept of the comparison rate some years ago. It’s designed to help you understand the “true cost” of a loan. It does this by looking at most of the fees and charges that apply to a loan, and then assuming a loan of $150,000. That way, you can compare interest rates across very different loans.

As an example, a loan with a very low headline rate – say 6 percent – might look really attractive when compared to one with a headline rate of 6.5 percent. But if the 6 percent loan has a $500 per year fee, then it may end up being just as expensive, especially if the 6.5 percent rate doesn’t have recurring fees. In this case, the comparison rate will be a reasonably accurate guide to help you compare interest rates more accurately between the two loans.

Ask your lender about revert rates

Comparison rates aren’t perfect. For example, they don’t work very well when comparing a fixed rate loan to a variable, because it assumes you automatically get the revert rate when the fixed period ends. However a lot of fixed loans revert to a higher interest rate at the end of the fixed term.

In fact, most people refinance to another fixed rate or a better variable rate home loan. However, when you want to compare interest rates, it’s a reasonable tool to put two loans side by side, so you should always look at the comparison rate as well as the headline rate.

Use the RateCity mortgage repayment calculator to compare home loans so you can quickly spot and eliminate the home loans that will empty your pockets out sooner.

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