If you’re in the market for a home loan, be sure to check out the “comparison rate” as well as the headline interest rate. It could be the key to avoiding a loan that comes stacked with unwanted fees and charges.
Whenever you see a home loan advertised, you’ll see two rates displayed - the headline rate and also a comparison rate (sometimes with “CR” written next to it). This comparison rate is an important piece of information but home buyers don’t always understand what it’s all about.
By way of background, lenders are required by law to advertise both the main interest rate as well as the comparison rate. It’s designed to help consumers make better choices because the comparison rate incorporates the annual interest rate as well as the cost of most upfront and ongoing fees. So it’s a reasonable guide of the true cost of a loan.
Some seemingly cheap home loans – with a lower interest rate – can be laden with fees, which makes them not so cheap at all. The comparison rate reveals this and enables borrowers to compare loans on an apples for apples basis.
To give an example, a $300,000 loan with an annual rate of 4.0% can look very attractive. But if it also comes with upfront fees of $800 and monthly fees of $35, the comparison rate can rise to 4.22%, which is far higher than the headline interest rate.
The downside of the comparison rate is that it is typically based on a $150,000 loan payable over 25 years. It’s unlikely this will match the loan you’re looking for, and the best way around this is to ask lenders for the comparison rate that applies to your level of borrowing.
While it always makes financial sense to save with a low rate, bear in mind that getting value on your home loan isn’t just restricted to the rate you pay. Loan features play a valuable role too.
In particular, look for a home loan that allows fee-free extra repayments. Virtually all variable rate loans on the market offer this but do check. Some fixed rate loans even permit extra repayments up to a certain value annually.
This is something to look for as extra repayments are essential in reducing your overall interest bill and farewelling the mortgage sooner. Best of all, even small additional repayments can be highly effective in cutting years and potentially thousands of dollars from the cost of your home loan.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.
The first strategy is to always pay more than the minimum.