Balancing Interest Rates with Loan Features
Most people think comparing home loans on just the advertised interest rate alone, is the most accurate way to compare different loans from different funders.
But they’d be wrong.
There’s little value in having a loan with the cheapest interest rate if it doesn’t also have the features you need and the options you want.
Here are six steps to help you start your thinking when comparing home loans.
Many funders advertise incredibly low-interest rates to lure in unsuspecting (or time poor) borrowers who 12 months later, suddenly find the interest rate on their new loan is suddenly higher than they originally planned for.
The classic example is the loan with the Honeymoon Interest Rate.
Most Honeymoon rate loans have incredibly low rates for a 12 month honeymoon period, after which it reverts to a higher interest rate.
This may mean your interest rate is now well above what other mortgage holders are paying.
Most of these loans after 12 months simply revert to the individual funders Standard Variable Rate (SVR) often the highest rate, typically 1 - 2% higher than what they started off.
Displaying Comparison Rates were made mandatory in an attempt to stop lenders from advertising incredibly low-interest rates to lure unsuspecting borrowers into loans that in reality cost them far more than they expected.
Credit providers who advertise interest rates must also advertise the Comparison Rate.
- You’ll now see the rate displayed alongside the advertised rate with the caption, ‘Comparison Rate’
A comparison rate is designed to help you work out the true cost of a loan.
- It reduces to a single percentage figure the interest rate plus most fees and ongoing charges relating to a loan
- The comparison rate helps you to compare loans from different lenders to find out how much it will cost you
The table below shows a practical example of how the comparison rate reveals the effective interest rate on an advertised loan.
Can you see the difference?
|Interest rate||Fees & charges||Comparison rate|
|Home Loan A||8%||0.5%||8.5%|
|Home loan B||8.25%||0.1%||8.35%|
In the example above, home loan B will cost less than home loan A, even though home loan A has a lower interest rate.
As part of an application for a home loan, you should be asked to complete a household budget.
This is to show the funder you have considered the importance of spending less than you earn and show you have the required budget available to service and repay the new debt
All credit providers are required to provide Key Fact Sheets outlining the key features and costs of the loan.
The key facts sheet will give you the information you need, in a set format so you can directly compare features, interest rates and fees.
Now you know what to look for in the Comparison Rate, you'll be able to better understand the effective interest rate that you're considering.
When you're beginning your thinking about shopping around for a loan, you’ll also need to compare the features you need and the options you want.
Loan features can include:
- Offset accounts
- Redraw facilities
- The ability to make principal reductions during a fixed rate term
- Portability of the loan across different securities.
As loan features really need to be mapped to your individual needs, this is a great conversation to have with your financial advisor, like Sapience. (shameless plug I know but we’ve been doing this for 20+ years and we’re rather good at what we do).
- When comparing interest rates, Comparison Rates take the hard work out of comparing the cost of different loans.
- When comparing features, read the Key Fact Sheet of different loans and have a conversation with your financial adviser, like Sapience.