Comparison rates v interest rates – what’s the difference?

If you’ve been looking at home loans, you’ll have noticed that lenders publish two rates side-by-side. There’s the ‘interest rate’ and the ‘comparison rate’. The comparison rate is usually a little bit higher than the interest rate. 

You can see what we mean on our Compare home loans page.

So what is a ‘comparison rate’, when we’re talking about a home loan. And why is it different from the interest rate?

Comparison rate explained

Essentially, the comparison rate represents the true cost of a loan when all the loan costs are added in.

It’s the advertised interest rate, plus other fees and charges such as establishment fees, annual fees and other items, that give you a picture of the overall costs that come with setting up and maintaining a home loan.  More about what those include, shortly.

Why comparison rates are important

Because the comparison rate is calculated by taking into account the charges and fees that come with the loan, as well as the advertised interest rate, it makes it easier to see and compare what the overall cost may be, when you’re shopping around for a home loan. 

So whilst the advertised interest rate will tell you the rate of interest you’ll pay on your home loan, it doesn’t reflect the entire true cost of the loan because it excludes some of the fees and charges that come with it.  These costs can vary between lenders.

The comparison rate includes some of these additional costs, which makes it easier to compare different products from different lenders, and helps you decide on the loan that fits with your budget, life stage, long-term financial goals and financial situation.

The loan with the lowest interest rate isn’t always the cheapest option. A lender may offer a low interest rate but charge very high fees, and therefore the home loan could cost you more in the long term.

The difference between an interest rate and a comparison rate 

The interest rate on your home loan, refers only to the interest you pay on the loan’s balance, whereas the comparison rate also includes some of the additional costs that you’ll need to pay the lender.

Let’s take a closer look at interest rates and comparison rates.

Interest rates

When you buy a home using a home loan from the bank, the bank will charge you interest on the loan balance, calculated using the interest rate on your loan.  Making additional repayments or increasing the frequency of your loan to weekly or fortnightly, will help you save interest.  You can use the RAMS mortgage calculators to run the numbers on your home loan and see what the interest payments might look like.

Comparison rates

If the comparison rate is similar to the interest rate, any extra costs are probably minimal.  If the comparison rate is a lot higher than the interest rate, there may be significant ongoing fees and charges attached to the loan which may mean the loan could cost more in the long term. If that’s the case, you may want to ask the lender for a breakdown of these extra costs and see how they affect your potential monthly repayments.

It’s also important to know that a comparison rate does not include the mandatory government fees and charges that are standard across all home loans.  

How is a comparison rate calculated?

The comparison rates you’ll see on the lenders website or advertised are calculated based on a home loan’s interest rates, fees and charges, using a standardised formula set out in the National Credit Code.  All financial institutions and mortgage providers in Australia use this formula. That formula is based on a $150,000 loan amount, over a 25-year term.
However, it is important to know that nowadays, the average home loan amount in Australia is much larger than that, and there are many different loan terms available. Different amounts and terms will result in different comparison rates.

You can see what a comparison rate could include, and doesn’t include, below.

A comparison rate typically includes:

• Interest rate
• Valuation fees
• Loan application fees
• Other establishment or upfront fees
• Ongoing fees
• Exit or discharge fees.

A comparison rate does not include:

• Fees associated with optional features, like a redraw or offset account
• Government fees, such as stamp duty, mortgage registration and land tax
• Late payment fees
• Early repayment or additional repayment fees
• Lenders mortgage insurance. (LMI)

You may not incur some of these costs, but it’s worthwhile considering which might apply to you.

The background to comparison rates (impress your friends!)

The Australian government created comparison rates to give home buyers some transparency when they’re shopping for home loans. They help to see the true cost of borrowing over the life of the loan.

All lenders use the same formula to calculate the comparison rate, which makes it easier for borrowers to compare different home loan products offered by different lenders.

However, comparison rates are not perfect and should be used as a guide to inform you of the true cost of a home loan.

That’s because:

• The comparison rate doesn’t include all the extra fees and costs associated with a home loan, only some of them. You may have extra costs and fees which you’ll need to add to your calculation.
• It’s a straight comparison based on cost, so it doesn’t factor in features offered by lenders that may make a loan more attractive, such as flexible repayment arrangements or access to fee-free accounts.

It’s important to remember that the actual cost of your home loan will depend on your unique loan scenario, and you’ll need to do your own calculations to discover exactly what you’ll pay for your home loan.

That includes the amount of your home loan, the term, repayment frequency, interest rate, and all additional fees and charges attached to your individual loan, as well as the mandatory charges that come with purchasing a property.  Our RAMS mortgage calculators may help you work out your costs.

Choosing a home loan

If you have any questions about comparison rates or anything related to home loans or buying a home, we’re here to help. Home loans are what we do.

This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice.