Mortgage Comparison Rates: What are they and how do they work?

When comparing home loans, you'll notice two different rates: 

• The interest rate
  This is the percentage charged by the lender on your loan balance

• The comparison rate
  This gives a truer picture of the total cost by factoring in fees, charges, and the impact of temporary discounts

While the interest rate might grab your attention, the comparison rate is arguably more important. It helps borrowers avoid misleadingly low interest rates that may come with hidden costs.

Let's dive into what a comparison rate really means and why it's crucial for mortgage shoppers.

What is a home loan comparison rate?

The comparison rate represents the holistic cost of a mortgage, including interest and fees and leveling out fixed rate periods and temporary discounts.

It essentially takes the overall cost of a $150,000 home loan over a 25-year period, condensing it into a digestible figure representing the typical annual cost.

Products with a low interest rate and a high comparison rate likely have significant fees, a high revert rate, or a significant honeymoon discount rate – or a combination of the three.

Lenders legally have to supply comparison rates to prospective borrowers - a law that's enforced by ASIC.

What costs are included in the comparison rate?

The comparison rate encompasses most fees and charges a bank or lender will demand a borrower pays. These include:

• Interest at the advertised rate

• Application and settlement fees

• Monthly and/or annual fees

• Discharge or exit fees

It doesn't include government charges (like stamp duty or mortgage registration fees), fees charged for optional features (like an offset account), or avoidable fees (like late repayment fees).

What it means if the comparison rate is higher than the interest rate

It can be shocking when you think you've found an ultra-competitive home loan interest rate, only to notice the comparison rate is oodles above. This can mean a few things:

• Expensive or numerous fees
  A high comparison rate can be a warning that a lender charges significant upfront, ongoing, or exit fees. It's relatively common on packaged mortgage products, which may come with a lower interest rate and in-demand features, but tend to charge hefty monthly or annual fees.

• Honeymoon interest rate period
  Some mortgage lenders attract borrowers with a competitive, temporary interest rate discount, which may be applicable for the first year or two a person holds their mortgage. The comparison rate will reflect the fact that, once the honeymoon period is over, the repayments will jump.

• Fixed rate period
  Fixed home loans offer repayment certainty for a set amount of time, after which a home loan will likely be subject to a variable interest rate.

Comparison rates on fixed rate home loans

If you're shopping for a fixed rate home loan, you've likely noticed that comparison rates are typically significantly higher than the interest rates advertised on these products.

That's largely because of what's called the revert rate. That is, the rate a home loan reverts to after a fixed rate period ends.

A revert rate is generally variable, and might even be a lender's standard rate – which is often higher than rates advertised by the same lender.

But fear not. Lenders typically reach out to borrowers before the expiry of their fixed rate period to offer them a more competitive variable rate or a new fixed rate term. Meaning, comparison rates on fixed mortgages often don't reflect reality.

Beware, however, a fixed rate with a similar or identical comparison rate
Your Mortgage has previously come across fixed rate products that automatically reinstate the original fixed rate period on its expiry – effectively potentially locking a borrower into another fixed rate term, whether they want one or not. These products typically boast comparison rates very close to the advertised interest rate.

What it means if the comparison rate is lower than the interest rate

It's pretty uncommon for a home loan's comparison rate to be lower than its interest rate – but not unheard of.

This might happen if:

• A variable rate home loan includes built-in rate discounts
  As is the case with Unloan's lineup, which offers a 0.01% p.a. interest rate discount for each year a borrower holds their mortgage

• A home loan's rate is lowered when a borrower meets certain milestones
  As is offered by Athena's AcceleRATES feature, which automatically drops a borrower's variable rate when they surpass certain loan-to-value ratio (LVR) thresholds

However, if the numbers don't add up, it could be a mistake or a signal that a loan is structured in an unusual way. Always read the fine print!

Should I always choose the mortgage with the lowest comparison rate?

All this might leave you feeling like the lowest comparison rate is the best deal. But the lowest comparison rate (or interest rate, for that matter) doesn't always mean the best value for money.

There are other factors to consider when choosing a mortgage. Most notably, what you need from a home loan product.

The 'cheapest' mortgage might not offer features like an offset account - and if you have decent savings or you're an efficient saver, an offset account might save you more than a lower rate over time.

There might be other factors at play too. For instance, if you're a first home buyer with a deposit of less than 20%, it might make more sense to borrow with a lender that's part of the Home Guarantee Scheme. That way, you could avoid paying for Lenders Mortgage Insurance (LMI), potentially saving you more than a lower rate would have.

Bottom line: A low comparison rate is a great indicator, but don't ignore features that could save you more money in the long run.

In the market for a competitive home loan? Here are some of the best available right now:

Important Information and Comparison Rate Warning

_{Image by Raquel Martínez on Unsplash}