When shopping for a home loan in Australia, you'll encounter two different interest rates: the advertised rate and the comparison rate. While many borrowers focus on the headline interest rate, the comparison rate often tells a more complete story about the true cost of a loan. Understanding the difference between these rates is essential for making an informed borrowing decision.

What is a Comparison Rate?

A comparison rate is a single percentage figure designed to help borrowers identify the true cost of a loan. It combines the interest rate with most fees and charges associated with the loan, expressed as a single annual percentage. Australian lenders are legally required to display comparison rates alongside advertised interest rates for home loans and certain other credit products.

The comparison rate system was introduced by the Australian government to increase transparency in the lending market. Before its implementation, lenders could advertise attractively low interest rates while obscuring significant fees that substantially increased the overall cost of borrowing.

How Are Comparison Rates Calculated?

Comparison rates are calculated using a standardized formula set by Australian Consumer Law. The calculation is based on a specific loan scenario: a secured loan of $150,000 over a 25-year term with monthly repayments. This standardization allows borrowers to compare apples with apples across different lenders.

The comparison rate calculation includes several cost components. The base interest rate forms the foundation. On top of this, the calculation incorporates establishment fees, ongoing account-keeping fees, and other regular charges that apply to the loan. These fees are spread across the loan term to produce the single comparison rate percentage.

However, it's important to note that comparison rates don't include every possible cost. Government charges like stamp duty and mortgage registration fees are excluded because they vary by state. Redraw fees, costs for additional repayments, and fees that only apply if you take certain actions are also not included. Lenders mortgage insurance (LMI), which applies to loans with less than 20% deposit, is similarly excluded.

Why the Gap Between Interest Rate and Comparison Rate Matters

The difference between the advertised interest rate and the comparison rate reveals how much fees add to your borrowing costs. A loan with a very low interest rate but high fees might have a comparison rate that's significantly higher, indicating it may not be as cheap as it first appears.

For example, consider two loans: Loan A has an interest rate of 5.99% and a comparison rate of 6.05%, while Loan B has an interest rate of 5.89% and a comparison rate of 6.25%. At first glance, Loan B appears cheaper based on the interest rate alone. However, the comparison rate tells us that Loan B has higher fees, making it more expensive overall than Loan A.

Generally, a small gap between the interest rate and comparison rate indicates lower fees, while a larger gap suggests more significant fee components. As a rule of thumb, a gap of 0.1% or less typically indicates a loan with minimal fees, while a gap of 0.3% or more warrants closer examination of the fee structure.

Limitations of Comparison Rates

While comparison rates are a useful tool, they have several limitations that borrowers should understand. Being aware of these limitations helps you use comparison rates appropriately while considering other factors in your loan decision.

Standardized assumptions don't match your situation. The comparison rate is calculated on a $150,000 loan over 25 years. If you're borrowing $500,000 over 30 years, the impact of fixed fees will be different in your situation. A $500 establishment fee has a much smaller proportional impact on a larger loan than on the standardized $150,000 loan amount.

Fixed-rate loans present complications. For fixed-rate loans, the comparison rate assumes the interest rate reverts to the lender's current variable rate after the fixed period ends. This means the comparison rate for a fixed loan might look less attractive than it actually is if variable rates are higher than the fixed rate you're locking in.

Features aren't reflected. The comparison rate doesn't account for valuable features like offset accounts, redraw facilities, or the flexibility to make extra repayments. A loan with a higher comparison rate but a 100% offset account might save you more money than a lower-rate loan without this feature.

Changes over time aren't captured. The comparison rate is a snapshot based on current rates and fees. It doesn't predict how variable rates might change or whether the lender might increase fees in the future.

How to Use Comparison Rates Effectively

To make the most of comparison rates when shopping for a home loan, consider these practical approaches:

Use comparison rates as a starting point, not the final answer. They're excellent for quickly filtering out loans that are more expensive than they appear, but shouldn't be your only consideration when making a final decision.

Compare like with like. When comparing loans, ensure you're looking at the same type of product—variable with variable, fixed with fixed, and similar loan features. Comparing the comparison rate of a basic variable loan with a featured fixed loan isn't particularly meaningful.

Calculate your actual costs. Use tools like our loan repayment calculator to work out what you'd actually pay based on your specific loan amount and term. Add in the fees that apply to your situation to get a more accurate picture of the total cost.

Consider the full package. Factor in features that matter to you, customer service reputation, and the flexibility of the loan. Sometimes paying slightly more for a loan that better meets your needs is worthwhile.

Comparison Rates and Different Loan Products

Different types of home loans interact with comparison rates in various ways:

Basic variable loans typically show the smallest gap between interest rate and comparison rate because they have minimal fees and no costly features.

Feature-rich variable loans often have slightly higher comparison rates due to ongoing package fees, but the features (like offset accounts) might save you more than the fee costs.

Fixed-rate loans can show misleading comparison rates because of the reversion rate assumptions. Focus on the fixed rate itself and what you expect to pay during the fixed period.

Split loans (part fixed, part variable) typically display a blended comparison rate that reflects both portions of the loan.

Conclusion

Comparison rates are a valuable transparency tool that helps Australian borrowers understand the true cost of a home loan beyond just the headline interest rate. They're particularly useful for identifying loans where fees significantly add to costs. However, they should be used as one factor in your decision-making process, not the only one.

When comparing home loans, start with comparison rates to narrow your options, then dig deeper into the specific fees, features, and flexibility each loan offers. Consider your individual circumstances—loan amount, term, and how you plan to use the loan—rather than relying solely on the standardized comparison rate calculation. Use our loan repayment calculator to model different scenarios and find the loan that truly offers the best value for your situation.