Mortgage comparison rates are one of those government legislation's that try to help, but miss the mark and actually do the opposite. Mortgage comparison rates are meant to take into account other fees and charges, not just the mortgage interest rate, to give you an overall interest rate however there are a couple of problems with this.
Firstly, by taking flat dollar fees and converting them to an interest rate, an assumption needs to be made on the loan size and length of time the loan is repaid. This is standardised as a $150,000 loan paid off over 25 years. Based on all the possible loan sizes and actual repayment lengths, this might suit 1 mortgage holder in Australia out of millions.
Lets have a look at some of the problems. Some loans might charge a 5.1% interest rate with no annual fee, or if you pay a $200 annual fee, you get the discounted rate of 5.0%. So if your loan is above $200,000, it's a no brainer, you pay the annual fee to get the discount. BUT, the annual fee loan will then show a worse comparison rate, because they are all calculated with a loan balance of $150,000. In real life you wouldn't stick with the 1 loan for 25 years. You'd pay the annual fee for the discounted rate until the loan balance was below $200,000, then you would revert to the no annual fee option.
The other big problem with comparison rates is when it comes fixed rate loans. For fixed rate loans, the comparison rate is still on the same mortgage size and with a term of 25 years, but fixed rate loans are generally only fixed for up to 5 years. In these instances, the comparison rate is calculated by reverting the loan back to the standard variable rate for that lending institution for the remaining term of the loan. This is just going to give you all sorts of inaccurate figures on the comparison loan. The bank may be offering a great fixed rate but has a terrible variable rate, so the comparison rate on the fixed loan will show a bad outcome, even though it may be a good option for you, just for the fixed period.
It isn't hard to calculate how much a loan is going to cost you. Multiply the interest rate by your loan balance then add on any flat fees the bank charges annually. This will show you the annual cost in dollar terms for you. Then, if there is an upfront fee, you need to apply some qualitative analysis here as well as quantitative, is it worth it? If an upfront fee is $500 but the loan is saving you $3,000 a year, it won't take long to get your money back. But if the upfront fee is $500 but the loan is saving you $100 per year, you might think, too many things could change in 5 years for this to even pay me back.
I think with the competition and the constant changes in the mortgage market as well as changes to your own personal circumstances, you'd be crazy to stay with the same loan for 25 years, so the comparison rate shows you very little, you just need to take it upon yourself to look at the other costs outside of the interest rate. At Precision Wealth Management we can help clients get mortgages with the interest rate rebated, so the interest rates out clients pay are less than any advertised interest rate or comparison rate. Call us on 1300 200 012 to see how we can help you.
