What’s the difference between an interest rate and a comparison rate?
When shopping around for a home loan product, you want to do your due diligence. It’s really important to have a good understanding of how much a loan could cost you compared to other loans, and what’s the most appropriate loan type and rate for you.
An interest rate and comparison rate often sit side-by-side and appear to be quite similar. But what’s the difference?
When you buy a home, you’ll most likely need to borrow money from a bank to pay for the property. The lender will charge you ongoing interest on the funds you are repaying – known as the interest rate. The amount you’ll pay in loan interest is calculated as a yearly percentage of the total amount borrowed. The interest rate is referred to as the ‘headline rate’ in some contexts.
For example, if you borrow $300,000 for a home loan over 30 years with an interest rate of 3%, you will pay roughly $155,332 in interest to your bank over the life of the loan. Westpac has a range of online calculators that can help you run the numbers on your home loan.
A comparison rate is really helpful when comparing different loan products and offers. As the ‘headline rate’ (interest rate) doesn’t always give the full picture of costs attached to a home loan, the comparison rate attempts to take these additional costs of the loan into account - giving you an idea of the true cost of a loan. For that reason, the comparison rate is generally higher than the interest rate, because it gives a more realistic picture of additional costs, such as:
- Application fees
- Set up fees
- Ongoing fees
- Exit or discharge fees
If the comparison rate is a lot higher than the interest rate, this may suggest there are some significant ongoing costs attached to the mortgage apart from interest charges. If the comparison rate is similar to the interest rate, this may suggest there are minimal additional fees and charges to factor in to the overall cost of the loan.
Why are interest rate and comparison rates important?
Loan interest rates and comparison rates allow you to compare home loans in the market on a fairly even footing. They’re a good tool to help you understand how the cost of one loan might compare to another, so you can choose the right home loan for your circumstances.
An interest rate can be used to work out how much the interest charges on your mortgage may be.
On the other hand, a comparison rate includes an estimate of the fees and charges as well as the interest charges of the mortgage, so you can compare the true cost of different loans more easily. It’s the simplest way to understand the true cost of a loan and find out which loan will be the best value over time.
Something to keep in mind about comparison rates
Comparison rates were created by the Australian government to offer more transparency to people shopping the home loan market.
One important thing to remember about comparison rates: they should be used as a guide – not gospel. This is for a few reasons…
The rates are defined by legislation and calculated on a loan of $150,000 over a 25-year term – not your personal situation. The average mortgage size in Australia is much higher than $150,000 and your loan term may be longer or shorter than 25 years.
On top of that, while a comparison rate gives you more context than just comparing interest rates, it’s important to know it doesn’t cover all costs and fees that may be associated with a home loan.
You can see which fees and costs are included (and not included) in comparison rates below.
So when looking at comparison rates, you’ll need to think about whether you have extra costs and fees to add into the mix – as this will slightly alter the cost of your loan.
Keep in mind: comparison rates can help you weigh up different home loan options so you can estimate the true cost – they're not 100 per cent accurate, but you can definitely use them to guide your decision.
How to find the right home loan for you
When deciding on the home loan that’s most appropriate for your situation, you’ll need to factor much more into your decision than just the cost of the interest and comparison rates. Choosing a loan is a big deal – picking the right one can potentially save you thousands of dollars and might even put you in a situation where early repayment is on the cards. But you first need to understand your personal financial situation and how that translates to the types of home loan available to you. Make sure you think about the following:
How much money will you borrow from your lender? Don’t forget: the more you borrow, the more interest you’ll pay over the life of the loan. Our borrowing power calculator can help you find out how much money you could potentially borrow, as well as how much you can afford to repay.
Have a think about how quickly you'd like to pay off your home loan, considering that most home loan terms are over 25 years. Can you pay off your home loan faster than the loan term? The longer you take to repay the funds, the more interest you’ll accumulate. Use our mortgage repayment calculator to see how much interest you could save with an early repayment.
Fixed rate vs. variable rate
Working out which type of interest rate works best for your needs is an important consideration when choosing a home loan. The type of rate you choose will also come with a different comparison rate, so it’s important to understand how they differ.
Fixed rate home loans provide you with stability in terms of repayments, but also lock you into the mortgage for a set term. This means that you can fix in the interest rate with your lender and be certain that your repayment amounts won’t change for the duration of the fixed rate term.
Variable rate home loans give you more flexibility, but you may be impacted by interest rate rises. When you take out a variable interest rate home loan, you can also get ahead with no limit on the amount you can make in extra repayments.
Depending on your lender and home loan, in some cases you can split your loan balance into two different accounts, one with a variable interest rate and one with a fixed interest rate. Splitting your home loan balance with a fixed and variable interest rate allows you to benefit from the flexibility and certainty of each rate type.
Interest-only repayments vs. principal and interest repayments
When you take out a home loan, there are generally two home loan repayment options available to you – interest only and principal and interest.
If you choose interest-only repayments, you’re only paying off the interest portion of your home loan, plus any fees. The total amount you have borrowed stays the same. Selecting interest only repayments means that your repayments will be lower for a set period of time, but these repayments will be higher when the interest only period ends. Interest-only rates may also be higher than principal and interest rates – they’ll also come with a higher comparison rate.
Principal and interest repayments go towards paying off the amount you have borrowed (the principal) and the interest, plus any fees. By the end of the loan term, you’ll have repaid the amount borrowed, the total interest owed – and you will be mortgage-free. If you want to know more, read about the difference between the two repayment types.
Extra fees and charges
You may need to pay a range of home loan fees and charges when buying or selling property that are not accounted for in the loan’s comparison rate. This could include things like application fees (settlement, ongoing or discharge fees) or lenders mortgage insurance.
You’ll also want to take into account any extra features you’d like to have as part of your home loan, like an offset account, redraw facility or construction option. These additional loan features may change the interest rate you get or add costs. You might also need to pay redraw fees if you choose to take funds out of the account.
These fees and charges will vary depending on your personal situation, lender and type of home loan, but it’s a good idea to keep them in mind when choosing a home loan.