What is a comparison rate, and how is it calculated?

Comparing different home loans is one of the best ways that Australians can ensure they’re choosing the best mortgage for their financial situation and goals. And a comparison rate is one tool available to would-be buyers that will help them on their journey.

Banks and lenders will charge you interest on top of your loan amount (also known as the principal) over a loan term – typically 25-30 years. While interest charges are arguably the biggest cost associated with a mortgage, it is not the only cost. The lender may also charge upfront and ongoing fees, such as application fees, annual fees or extra repayment fees.

So, how do you get a better understanding of the true cost of a loan? This is where the comparison rate comes in. Let’s explore what a comparison rate is for a home loan, how it differs from an advertised rate and how you can use it to compare your mortgage options.

Everything you need to know about comparison rates

What is a comparison rate?

A comparison rate is an indication of a home loan’s overall cost, combining its interest, fees and other standard charges into a single percentage rate.

From July 2003, the Australian government made it mandatory to display a comparison rate alongside an advertised interest rate, whether that’s for a home loan, personal loan, credit card, car loan, or other form of credit.

Looking at the comparison rates of two or more home loans may also help you estimate which mortgage may end up costing you more or less money overall.

How are home loan comparison rates calculated?

To ensure that home loan comparison rates remain consistent across the mortgage market, they are calculated from the same starting point.

A comparison rate is based on a 25-year term on a $150,000 loan amount, making principal and interest repayments. The comparison rate is calculated using these assumptions and factoring the advertised interest rate, as well as most standard fees and charges.

All of these factors are combined to work out the approximate total cost of this example home loan, which is expressed as a single percentage of the loan value, just like an interest rate – this is the comparison rate. 

Rates vs comparison rates

A borrower is comparing two home loans with two different advertised rates. At first glance, a home loan with an advertised rate of 6% may appear cheaper than a home loan with an advertised rate of 6.25%.

However, if the first home loan’s fees and charges cost approximately the equivalent of paying 0.5% extra interest, and the second home loan’s fees and charges cost approximately the equivalent of paying just 0.1% extra interest, the second loan could end up costing less in total than the first loan.

The comparison rate would then be able to reflect this, and help potential borrowers to identify the more expensive option.

Is it really the 'true cost' of a home loan?

It’s important to consider comparison rates as a good starting off point and not an exact measurement of what you may pay in monthly repayments. This is because the assumptions used to calculate a comparison rate may not match the circumstances of your home loan. 

Loan sizes have changed

Comparison rates are based on a loan amount that was more realistic in 2003. Nowadays the average mortgage size is closer to $600,000 than $150,000. 

The actual cost the comparison rate is trying to discover may be higher, depending on your home loan amount. And the larger a home loan, the smaller the impact that fees and charges are likely to make on the total cost compared to the interest rate.

You may instead want to use a comparison rate as a way to judge potential fees if the difference between the rate and comparison rate is significant. For example, if the advertised rate was 6%, and the comparison rate was 7%, you could guess the lender charges hefty fees - regardless of your loan size. 

Not every cost is included

It’s also important to remember that a comparison rate doesn’t necessarily include every cost of a home loan, as some mortgages have nonstandard charges to consider, such as fees associated with loan options that you may not choose to use (e.g. early repayment fees or redraw fees).

Doesn’t account for features

Finally, a comparison rate doesn’t account for some of the extra features and benefits that may be on offer, and that typically cost borrowers more, such as an offset account. You’ll need to decide for yourself whether these features justify any extra cost.

Comparing home loans

While a comparison rate can be useful for making a quick and simple comparison of home loan costs, you may want to compare a range of factors to find a loan that suits you, including:

• The interest rate
• Fees and costs
• Features (offset account, redraw facility etc.)
• Introductory rate offers
• Cashback deals
• Real Time Ratings score

For a more accurate summary of a home loan’s overall cost and how it could impact your budget, use our helpful Mortgage Repayment Calculator. Alternatively, get in touch with a mortgage broker for more specialised information. 

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