Interest rate versus comparison rate

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If you’ve ever shopped around for a home loan, you’ll have noticed that two terms often pop up: interest rate and comparison rate. Understanding the difference between these two is important for anyone navigating the home loan market. So, let’s break down these concepts.

What is the interest rate?

Simply put, the interest rate on a home loan, which is often referred to as the advertised rate or the headline rate, is the rate at which interest accrues on your loan balance annually, directly affecting your overall loan balance. It's like the ticket price of a concert – the base cost of entry. This rate is significant because it directly influences your monthly repayments. Factors like the Reserve Bank of Australia’s decisions and broader economic conditions can affect interest rates.

What is a comparison rate?

The comparison rate is a rate that reflects the true cost of a loan. It's more comprehensive than just the advertised interest rate, as it includes both the interest rate and most of the fees related to the loan, rolled into a single percentage figure. The idea behind the comparison rate is to provide a single percentage figure that reflects the total annual cost of the loan, making it easier for borrowers to compare different loan products.

In Australia, the comparison rate is mandatory for lenders to display alongside the advertised interest rate. This requirement was introduced to bring transparency to the loan market, ensuring that borrowers are not enticed by low interest rates that may be accompanied by high fees. You can usually find the comparison rate beside the headline rate eg. “5.85% p.a. variable rate (6.35% p.a. comparison rate). Lenders must also provide a key fact sheet for the product they’re offering which must state the comparison rate.

The comparison rate is calculated based on a standard formula, typically assuming a $150,000 loan taken out over 25 years. While this provides a baseline for comparison, it's important to note that the actual comparison rate for your specific loan might be different, depending on your loan amount and term.

It's also important to know that the comparison rate does not include every possible cost. Costs like government fees, conveyancing fees, and certain conditional charges (like early repayment fees) are not included. Additionally, it does not account for the value of flexible loan features such as offset accounts or redraw facilities, which can also impact the overall cost and benefit of the loan.

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Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers.

Important Information and Comparison Rate Warning

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Interest rate vs comparison rate: What’s the difference?

The advertised interest rate is the percentage the lender charges on the principal loan amount. It influences the monthly repayment amount but doesn’t include any additional fees or charges associated with the loan.

On the other hand, the comparison rate provides a more comprehensive picture. It includes the interest rate plus most of the fees and charges related to the loan. This rate is expressed as a single annual percentage, making it easier to compare different loan products on a like-for-like basis.

While the interest rate gives an initial impression of the cost of the loan, the comparison rate offers a more accurate representation of the total cost over time. However, it's important to note that the comparison rate is based on specific assumptions, such as a set loan amount and term, and might not include all fees or reflect personal loan conditions.

How do lenders calculate the comparison rate?

The calculation of comparison rates is set by the Uniform Consumer Credit Code and involves a pretty detailed formula. Due to the complexity of the calculation, it's often recommended to use an online comparison rate calculator where you can simply plug and play.

All comparison rates are calculated based on a standard loan amount and term - in Australia that’s $150,000 over a 25-year loan term. This standardisation is meant to allow consumers to compare different loan products more easily, however, most mortgages are bigger than $150,000 these days and many loan terms are for 30 years, so it might not necessarily be 100% accurate.

Other factors that go into the calculation of the comparison rate include repayment frequency (generally monthly), the advertised interest rate on the product the lender is offering, and fees.

Fees that are typically used in the calculation of a comparison rate include:

• Application fee
• Pre-approval fee
• Valuation fee
• Documentation preparation fee
• Legal fee
• Settlement fee
• Monthly account fee
• Annual package fee
• Periodical admin fee
• Discharge admin fee
• Documentation preparation fee
• Settlement fee

What isn’t included in the comparison rate?

While the comparison rate provides a more comprehensive view of a loan's true cost than the advertised interest rate, it doesn't include every potential expense associated with a loan.

Key exclusions typically include:

• Government stamp duty  
• Conveyancing fees 
• Fee waivers 
• Break costs and early termination fees
• Deferred establishment fees 
• Any optional costs such as early repayment and redraw fees
• Extra features like offset accounts or extra repayments 

Why is the comparison rate important?

The comparison rate plays an important role in the home loan process by offering a more realistic picture of a loan's true cost compared to the advertised interest rate. This comprehensive rate includes additional fees and charges, providing a clearer understanding of the overall financial obligation of the loan. It simplifies the task of comparing different loan products, as it consolidates the overall cost into one figure, making it easier to weigh options from various lenders with different fee structures.

The comparison rate also enhances transparency in the lending market, protecting borrowers from being lured by attractively low interest rates while obscuring high fees. By mandating lenders to display the comparison rate, it ensures consumers are better informed, helping them avoid loans that may seem affordable at first glance but are expensive due to hidden fees.

As you can see from the table below, Home Loan B has a lower advertised interest rate than Home Loan A. But when you take the various fees into account, Home Loan A works out to be a cheaper product than Home Loan B.

	Interest rate	Fees and charges	Comparison rate
Home Loan A	5.85%	0.50%	6.35%
Home Loan B	5.20%	1.50%	6.70