Understanding Comparison Rates: Why the Advertised Rate Isn't the Full Story

Overview

When you see a home loan advertised at 5.29% p.a., it looks like a great deal. But the comparison rate next to it says 5.68% p.a. Which one tells you the true cost? Understanding the difference could save you thousands.

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 is legally required under the National Consumer Credit Protection Act 2009 — every lender in Australia must display a comparison rate alongside the advertised (or headline) interest rate.

The comparison rate rolls the headline interest rate together with most fees and charges associated with the loan into a single figure, making it easier to compare loans from different lenders on a more like-for-like basis.

For example, a loan with a low headline rate but high ongoing fees may have a higher comparison rate than a loan with a slightly higher headline rate but no fees.

How Is the Comparison Rate Calculated?

The comparison rate is calculated according to a standardised formula set out in the National Credit Code (Schedule 2 of the National Consumer Credit Protection Act). It is based on:

• A $150,000 loan amount
• A 25-year loan term
• Monthly repayments

The calculation incorporates:

• The headline interest rate
• Establishment or application fees
• Ongoing monthly or annual fees (such as account-keeping fees or annual package fees)
• Discharge fees

The comparison rate effectively answers the question: if all the included fees were converted into additional interest, what would the overall interest rate be?

Why Does the Comparison Rate Matter?

Lenders structure their products in different ways. Some offer a very low headline rate but charge significant ongoing fees. Others have a slightly higher rate but no fees at all. Without a comparison rate, it would be difficult to tell which loan actually costs less.

Example

Consider two loans:

Loan A looks cheaper based on the headline rate, but Loan B is actually cheaper when fees are included — as the comparison rate reveals.

Use our Loan Comparison Calculator to model this for your specific loan amount and term.

Limitations of the Comparison Rate

While the comparison rate is a useful starting point, it has several important limitations:

1. Based on a $150,000 Loan Over 25 Years

The standardised calculation uses a $150,000 loan, which is well below the average Australian mortgage. On a larger loan (say $600,000 or $800,000), fixed fees like a $395 annual package fee represent a much smaller percentage of the total cost. This means the comparison rate overstates the impact of fees for larger loans and understates it for smaller loans.

2. Does Not Include All Fees

The comparison rate does not include:

• Government charges (such as stamp duty or mortgage registration fees)
• Redraw fees
• Early exit or break costs (particularly relevant for fixed-rate loans)
• Lenders mortgage insurance (LMI)
• Valuation fees charged by the lender

These costs can be significant and should be factored into your overall comparison.

3. Does Not Account for Loan Features

The comparison rate does not capture the value of loan features such as:

• Offset accounts: An offset account can save thousands in interest over the life of a loan, but this benefit is not reflected in the comparison rate.
• Extra repayment flexibility: The ability to make unlimited extra repayments without penalty has real value.
• Redraw facilities: Free redraws versus fee-based redraws affect total cost.

4. Assumes You Keep the Loan for 25 Years

Most borrowers refinance or pay off their loan well before 25 years (the average Australian mortgage is held for around 4-7 years before refinancing). This means upfront fees have a larger impact than the comparison rate suggests, since they are amortised over a shorter period.

How to Use the Comparison Rate Effectively

1. Use it as a first filter: Sort loans by comparison rate to quickly identify which products are genuinely competitive versus those hiding costs behind low headline rates.
2. Then compare like-for-like: Once you have a shortlist, compare the total cost based on your actual loan amount and the period you expect to hold the loan.
3. Factor in features you value: If you maintain a large offset balance or make significant extra repayments, a loan with a slightly higher comparison rate but full offset and extra repayment facilities may save you more.
4. Model it: Use our Loan Comparison Calculator to enter your specific loan amount, term, rates, and fees to see the true cost difference.

What About Fixed-Rate Comparison Rates?

Fixed-rate comparison rates deserve extra scrutiny. The comparison rate for a fixed loan is calculated assuming the rate reverts to the lender's current variable rate after the fixed period ends. Since the revert rate is typically much higher than the fixed rate, fixed-rate comparison rates tend to be significantly higher than the headline fixed rate.

This makes it difficult to compare fixed and variable loans using comparison rates alone. For a more meaningful comparison, use our Loan Comparison Calculator to model the total repayments over your expected holding period.

Key Takeaways

• Always look at the comparison rate, not just the headline rate
• Remember it is based on a $150,000 loan over 25 years — adjust mentally for your actual loan size
• It does not include all costs or capture the value of offset accounts and other features
• Use it as a starting point, then do a detailed comparison for your specific situation

Compare loans properly: Loan Comparison Calculator | Calculate repayments: Mortgage Repayment Calculator.

Sources: ASIC MoneySmart, National Consumer Credit Protection Act 2009, Canstar, RateCity.