MARK BOURIS
There’s something of a home loan ‘rate war’ going on at the moment, which can be great for borrowers. However, it can also creates pitfalls for the unwary.
Take some mortgage advertising I saw this week: it promoted a variable mortgage rate of 4.65 per cent, but beside it was a ‘5.21% comparison rate’.
Look at the difference: on a $300,000 25-year mortgage at 4.65 per cent your total interest bill is $207,941. But if you pay 5.21 per cent, your costs total $237,198. The difference between what’s calculated from the headline offer and the actual costs over the long term is around $30,000.
This type of advertising is a common marketing device. The low interest rate is merely an ‘introductory rate’ which in this case lasts three years. And after three years the home loan reverts to a much higher rate.
When comparing various mortgages, it is the ‘comparison rate’ you should be focusing on. As it shows you what the full mortgage will cost you, which is the total interest cost of$237,198.
Comparing apples with oranges
SInce it is the key to understanding the cost of your loan it is worth taking the time to understand the comparison rate.
The ‘comparison rate’ is a legislated requirement brought in by the federal government. It was introduced in 2003 at a time when ‘honeymoon rates’ were popular and advertised interest rates were not informing borrowers about the true long term cost of their home loan.
It’s quite difficult for average borrowers to calculate what they really pay over the long term if they pay one rate for, say, two years and then revert to a ‘true’ rate for the next 23 years.
So to resolve the confusion the government mandated a formula that all mortgage lenders must use in their advertising. It includes unavoidable fees and charges, and interest rates over a set period, which creates the comparison interest rate.
Because all lenders have to use the same formula, the result gives a borrower the means to compare the true cost of a loan before they commit to it, and it gives some reality to the headline interest rate.
This regulation set by the government is important, but it only goes so far. The law says that a comparison rate must be co-located with the promotional rate, and with the same prominence. A comparison rate is useless unless borrowers are looking at it and registering what it means.
In talking to people, I often find that consumers misinterpret the comparison rate as “X” lenders best rate compared to “Y” lenders best rate. This is what is implied by some advertisers by the wording they use to compare their introductory rate to the comparison rate. The fact are, though, that this is not at all the case.
The comparison rate on your loan, is the rate you should use to compare with other competing loans. And when you do that some interesting patterns emerge.
When you look up the most affordable variable rate loans (4.6%-4.8%) at a site such as RateCity, you see that those lenders with the best ranking have comparison rates almost identical to their advertised rates – that is, the rate they advertise is basically what the borrower will pay. But other loans only start at 4.6 per cent, before reverting to something much higher.
The advertisements imply that start up rate that is lower than the comparison rate is a big advantage, but the facts are the opposite.
Consumers are easily confused by the terminology and practices of the financial services industry. So if you’re searching for something as important as a mortgage, and a comparison rate gives you a chance to level the playing field, you really must pay attention.