Comparison Rate Definition: How is it calculated?

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Posted date: May 1, 2015 | Tags: , | 62 Comments

So what is a Comparison Rate? A comparison rate is a tool to help consumers identify the true cost of a loan. It factors in the interest rate, fees and charges and displays a single percentage rate that can be used to compare various loans from different lenders. From 1 July 2003, the Australian Government made it mandatory to display a comparison rate for any advertisement of a credit rate – including home loans.

Factors effecting Comparison Rates?

Comparison rates are calculated on a number of factors, including:

  • loan amount
  • term of the loan
  • repayment frequency
  • interest rate
  • fees and charges (excluding government charges, such as stamp duty and mortgage registration fees)

How is the Comparison Rate Calculated? (with example)

The comparison rate is calculated based on the following numbers, no matter what your loan size is:

  • $150,000 loan amount
  • 25 year term
  • principal and interest loan

As shown above, the loan amount is actually based on $150,000, which is much smaller than the average home loan size in Australia (at the time of writing the average is $365,000). This means that any home loan that has fees associated with it, those fees have a larger than expected impact on the comparison rate.

For example, let’s look at NAB’s professional package: NAB Choice Package Home Loan. The example would be similar for CBA’s Wealth Package, St George’s Advantage Package, Westpac’s Premier Advantage Package and ANZ’s Breakfree Package.

  • NAB Choice Package home loan details:
  • Interest rate: 6.97% p.a. (please note: this rate is accurate at time of writing in 2011)
  • Establishment fee: $0
  • Monthly fee: $0
  • Annual fee: $395

Because of the way the comparison rate is calculated, the comparison rate for this product is 7.31% p.a. Let’s have a look below at two examples, one with a loan size of $150,000 and another with a loan size of $500,000 so you can see how the proportion of fees effects the cost of your home loan.

$150,000 loan size

  • Term: 25 years
  • $167,190 in interest over 25 years
  • $9,875 in fees over 25 years
  • $177,065 in total over 25 years (excluding principal component)
  • 5.6% of cost is made up in fees ($9,875 / $177,065)

  • $150,000 at 7.31209% interest over 25 years with $0 fees gives you exactly $177,065 in interest.
  • 7.31209% rounded to 2 decimal places is 7.31%
  • = 7.31% comparison rate

$500,000 loan size

  • Term: 30 years
  • $693,920 in interest over 30 years
  • $11,850 in fees over 30 years
  • $705,770 in total cost over 30 years (excluding principal component)
  • 1.7% of cost is made up in fees ($11,850 / $705,770)

$1,500,000 loan size (to highlight the difference)

  • Term: 30 years
  • $2,081,760 in interest over 30 years
  • $11,850 in fees over 30 years
  • $2,093,610 in total cost over 30 years (excluding principal component)
  • 0.6% of cost is made up in fees ($11,850 / $2,093,610)

With the difference of 1.7% (or 0.6%) in fees to 5.6% in fees, you can see that the comparison rate is being dramatically affected at the lower loan amount and depending on your loan size the comparison rate may not actually be a good comparison tool for your situation… Try to keep this in mind when comparing home loans.


62 Comments

Nick

Hi,
All readers please note:
This article heading is: “Comparison Rate Definition: How is it calculated?
meaning that when you read it you are expecting to find out how this calculation is done,
But isn’t this funny when you reach the point the writer says:
“””Because of the way the comparison rate is calculated, the comparison rate for this product is 7.31% p.a.””

So you conclude that either the writer does not know it either and what is being written is a load of abalone. Or he/she is biased and does wants to get you!!!






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