What is a Comparison Rate?
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By Rebecca Pike, money expert at Finder
When looking for a loan, a lot of borrowers are tempted to simply compare interest rates between lenders and pick the cheapest option. However, that’s not necessarily the best way to do it.
As a bank’s comparison rate will show you, you might end up paying more for your loan than you first realised.
Most people will have heard the term “comparison rate”. It appears alongside the advertised interest rate for a loan product (by law, lenders have to display it) and it can sometimes show quite a big disparity from the original rate.
So, what is it, and which rate will you end up paying?
What is a comparison rate?
Let’s start by looking at a standard interest rate. Quite simply, it shows you the amount of interest you will pay each year, based on the value of your loan.
A comparison rate, on the other hand, not only takes into account the interest you will pay, but any additional fees and charges added on top. The comparison rate is what the estimated true annual cost of the loan will be.
Additional fees banks might charge you for personal loans, car loans and more, include:
Application or establishment fees
Service or monthly fees
Late payment fees
Early repayment fees
Exit fees
Document preparation fees
Not all of these fees will be included in your final comparison rate, as explained further below.
How does a lender calculate the comparison rate?
It’s important to note that comparison rates are always calculated based on a hypothetical situation which may look nothing like your loan.
The comparison rate can be vastly different based on your individual circumstances. The establishment fees and monthly fees can vary based on loan term and amount. This is why it’s always important to speak to someone about your situation before making a decision based purely on either the interest rate or the comparison rate.
The comparison rate is typically calculated by using a formula that takes into account a number of items, including:
The actual interest rate
Fees and charges
Loan term
Loan amount
Payment frequency
What does a comparison rate mean for you?
Basing a comparison rate on a $150,000 home loan is not entirely helpful nowadays when the average loan size is closer to $600,000.
The differences between personal loan values also mean that the comparison rate you see online for a $30,000 loan will be totally different for your $5,000 loan.
But there are ways you can work out a more accurate comparison rate for yourself – and you should, to really understand if you’re getting the best deal.
You can use the following information about the loan you’re looking at to work out what the true comparison rate works out as:
Loan amount
Loan term
Repayment frequency
Interest rate
Monthly account fee (if any)
Annual fee (if any)
Establishment fee (if any)
Valuation fee (if any)
Mortgage documentation fee (if any)
Settlement fee
Luckily, lenders like Fair Go Finance are clear about their additional fees, and have calculators where you can change your loan term and loan amount to see the true interest rate and comparison rate.
Things to watch out for
As already mentioned, the comparison rate is assessed on a hypothetical loan that likely does not reflect your situation. The interest rate beside it may also be calculated based on a different loan size and loan length.
While the comparison rate does take into account additional fees and charges, it does not take them all into consideration. For example, you may be subject to fees such as redraw fees or early repayment charges. It also does not include external charges that come with purchasing a property, such as stamp duty. Similarly, it does not include options which may actually save you money, such as fee waivers and offset accounts.
So, while comparison rates will show you a more accurate picture of what your loan is likely to cost you, they don’t show you the complete picture. Your own circumstances and loan arrangements will have an impact on the final rate; it’s important to deep dive into the additional fees, and speak to your lender.
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