What is the comparison rate

While most consumers focus on the interest rate when taking out a loan, there is another rate that is just as important: the comparison rate.

The comparison rate provides the actual cost of the loan by combining the interest rate, fees, and additional expenses. It is represented as a single percentage. Using a comparison rate makes it easy to compare what different lenders have to offer.

With interest rates rising, and record numbers of Australians refinancing their mortgages for better terms, it's more important than ever to get around comparison rates. Understanding how they work will enable you to choose a mortgage that is less likely to cause financial stress.

“The comparison rate is helpful when deciding which home loan is right for you, as it takes into account some of the loan fees and costs,” says Dr. Diaswati Mardiasmo, director of national research at PRD Nationwide. Its purpose is to give you a better overview of the true cost of a loan compared to the interest rate.

All types of lenders are legally required to display the comparison rate wherever the prime rate is mentioned. This prevents the lender from advertising a loan as cheaper than it actually is.

However, the comparison rate is not comprehensive. Terms that could lead to savings, such as cash-back deals and the ability to pay additional installments, are usually excluded.

"The comparison rate includes the interest rate plus some fees and costs related to the loan," says Mardiasmo.

The goal is to help you determine the true cost of a loan and to compare loans and services offered by financial institutions and mortgage providers.

The formula for calculating the comparison rate is regulated by the Consumer Credit Act, and all Australian lenders are required to use this formula.

It is calculated using the interest rate and any additional fees and charges that may apply to the loan.

As Mardiasmo explains, there are three main categories of fees that are commonly used to calculate the comparison rate.

These include upfront fees such as pre-approval fees, settlement fees, and ongoing fees. They include monthly account fees, annual package fees, and periodic administrative fees.

The third type of fee is known as discharge fee: it is incurred when the loan is repaid. These include administrative fees for unloading, documents preparation fees and settlement fees.

Different loan amounts and terms will result in different comparison rates.

"Costs such as withdrawal fees or early repayment fees and cost savings such as fee waivers are not included in the comparison rate — but they may affect the cost of the loan," says Mardiasmo.

Government fees, such as stamp duty or mortgage registration fees, are also excluded. Nor are fees and charges that were not available at the time the price comparison was submitted.

Lenders are legally required to display the comparison rate alongside their stated interest rates.

It is important because it reflects the true cost of the loan, and whether it is something you can afford easily without falling into the stress of a mortgage.

"A loan with the lowest interest rate is not always the cheapest option," Mardiasmo explains.

“Based on interest rates alone, you might think two loans cost the same — but the comparison rate can help reveal whether one loan costs more than the other. It can also help you decide which loan is best suited to your budget and long-term financial goals.”

For example, a loan with a lower interest rate but higher fees and costs will have a higher comparison rate than a loan with a higher interest rate but lower fees and costs.

It tells you right away if a particular loan is a good value, because it indicates if the loan has any significant fees that may not be immediately apparent.

"When shopping for a loan, the comparison rate gives Australian borrowers a more accurate way to understand the true cost of a loan," says Mardiasmo.