The Comparison Rate that every lender is forced to publish by the regulators is a farce and in fact can lead to poor decision making for loan seekers.
Let us explain
What is a comparison rate?
Let’s start at the beginning – comparison rates were introduced in 2003 and required all credit providers (i.e banks, credit unions, non-bank lenders etc.) to produce the “true cost” of the loan. It is a single percentage figure that takes into account the headline interest rate plus most fees and charges that are attached to your loan.
This sounds great
The comparison rate, on the surface, seems like a great thing. It makes sure things like those nasty loan set up fees and ongoing service fees are considered in the total cost of the loan.
So what’s the problem?
The problem is this – all comparison rates are based off a $150,000 loan. Yes – that’s right – a $150,000. Now, unless you are buying a 20 square metre shack deep in the Great Victoria Desert or you have a $500,000 deposit a $150,000 loan won’t get you very far. In fact – the average new loan across Australia is now close to $450,000 with the number hitting almost $550,000 in NSW.
Why is this a problem?
The problem with using $150,000 as the basis for the comparison rate is it makes loans that have a higher ongoing fee look far more expensive that what they really are. Take a look at the examples below which compares NAB to some of the smaller lending institutions that currently have great rates:
Headline vs Comparison vs Adjusted Comparison Rate
|Headline Rate||Comparison Rate||Adjusted Comparison Rate|
|ME Bank||3.79%||NAB||4.12%||ME Bank||3.90%|
If you were to listen to the regulators and take the Comparison Rate as the “True Cost” of the loan you would rush to NAB as it looks like it is the cheapest by a fair margin. However, looking at our Adjusted Comparison Rate, which assumes your loan is a more realistic $550,000, all the loans are cheaper than NAB – most considerably so. The general rule is this – as the loan size gets larger, the comparison rate will trend towards the headline rate.
Should I ignore the comparison rate?
In a nutshell if your loan size is substantially larger than $150,000, which is likely, than you can pretty much throw comparison rates out the window. This is especially the case if you have more than one loan with a lender as a lot of the fees included in a comparison rate will only be occurred on your first loan.
While ignoring the comparison rate may make comparing loans more difficult – a good mortgage broker (like the ones we have at Plenty) will be able to guide you through the maze and help you discover the True True Cost of a loan.
The information contained on this page is of a general nature and may not be appropriate for your personal circumstances. You should obtain personal financial advice before acting on this information.