Comparison rates are the notional interest rate that you would pay if all the fees and charges associated with your loan were rolled into the interest rate.
Compulsory comparison rate advertising has shifted consumer emphasis to getting the lowest rate that you can. But in doing so, comparison rates might be doing you a disservice.
Getting a loan at all these days is becoming increasingly difficult.
Most lenders now charge higher interest rates at higher loan to value ratios (LVR’s).
So after seeing low interest rate advertising, you might naturally think you are in line for those lower rates, only to find it doesn’t apply your LVR or deposit amount.
Unsure what your effective interest rate is compared to comparison rate? Ask a mortgage broker who can help you understand your options.
But comparison rates also don’t help you compare one of the highest costs of finance – mortgage insurance.
In fact if mortgage insurance were included in your comparison rate, then you would see a very different picture.
Typically the less deposit you have, the higher your interest rate.
If an 85% loan on a 450k house has an interest rate of 3.97%, then a 95% loan on a 450k house could have an interest rate of say 4.75%.
And if the mortage insurance on the 85% loan is about 4,820, then the mortage insurance on the 95% loan is about 15,946, or 11,126 more.
So, if there were no bank fees other than mortgage insurance, and if you included mortgage insurance in the comparison rate calculation, then the difference between the 85% loan and the 95% loan goes from 0.78% to about 1% more than the lower rate.
This is not a small difference. On a 400k loan its about $900 more in just the first year – and much more again if compared to the lower LVR rate.
So while the government has tried to simplify comparing rates, just looking at comparison rates is not enough.
But there is a way to keep the interest rate on the largest part of your total loan at the lower rate, and to pay a lot less mortgage insurance.
The answer is a bigger deposit, or if you don’t have a bigger deposit – a bigger deposit loan can also give you a better outcome – even if the deposit loan rate is higher.
As confusing as this might be, the bottom line is that focusing on just the comparison rates will not give you the full story. Your broker can help you see whether borrowing a small amount at a higher rate will help you achieve a bigger saving on your total borrowing costs.