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'Paying too much': Expert's interest rate warning

Peter Switzer
·4-min read
Woman vacuuming money out of man's pocket
Don’t get sucked in by low interest rates. Source: Getty

You could be paying too much if you don’t read this.

My Christmas gift to all would-be home loan borrowers or refinancers looking for a great lower interest rate is a warning and it goes like this: Beware the comparison rate of interest.

For years I’ve educated those determined to be money smart to understand the comparison rate of interest and I nearly fell off my chair when a bank offering what I thought looked irresistible actually could be less impressive than I thought.

A couple of banks are offering a four-year fixed rate of interest home loan at an unbelievably attractive 1.99 per cent. However, when you look at the comparison rate, it’s an equally unbelievable 3.66 per cent!

So is this a case of what consumer advocates warn us about — the old “bait and switch” trick. This comparison rate was actually created to make lenders tell borrowers the whole truth about their loan.

Over the years, lenders have added bells, whistles, fees and charges to a loan, so the effective rate of interest you might pay will be higher than you think.

Let me give you some examples.

UBank has a 2.34 per cent variable interest home loan. Because there are no other charges, the comparison rate is 2.34 per cent — exactly the same as the headline or advertised rate.

Essential Home Loan has a variable rate loan for 3.39 per cent but the comparison rate is 3.59 per cent.

The CBA’s four-year fixed rate loan is 1.99 per cent but the comparison rate is 3.66 per cent, but fixed rate loans with bells and whistles makes comparison rates less understandable.

Adrian Sheahan at Switzer Home Loans explained this confusing story.

“Fixed rate comparison rates are a little different because the calculations need to factor in the reversion rate at the end of the fixed rate period (in addition to the fees and charges),” he told me. “The reversion rate is usually the current variable rate and that is usually different to the fixed rate on offer.

“So in the case of the CBA calculation, the rate the loan reverts to at the end of the fixed rate period will be higher than the 1.99 per cent initial 4-year fixed rate. Using the reversion rate assumption above, the current advertised CBA Variable Rate is over 4 per cent so that rate will be used for the remaining 26 years of the loan term, not the 1.99 per cent initial fixed rate. That will, of course, inflate the comparison rate.”

Adrian also says comparison rates have become less useful because the formula assumes a loan amount of $150,000 and a loan term of 25 years. As he points out, “most loans are now of course much larger and the most common loan term is 30 years, so I regard comparison rates as an indicator of fees rather than a definitive comparison figure.”

Andrew Parson from Yellow Brick Road agreed with Adrian and made this good point: “The variable revert rate of 3.85 per cent is way out of market, so I would be suggesting that anyone taking that offer may be looking around or at least talking to CBA about sharpening up their interest rate at that time!

I think the best way to work out one loan from another might be to look at what you will have to pay back each month.

With the UBank variable rate loan at 2.34 per cent with a comparison rate of 2.34 per cent the monthly repayment is $1,300 a month on a $300,000 loan. But that’s also paying off some of the principal on the loan.

The CBA 4-year fixed charges you $1,300 a month for the same loan too but you are only paying interest. After four years, you’ll have to either go into a new fixed rate home loan or cop the reversion rate, which is really high.

For someone who worries about their cash situation, maybe because they over borrowed and like the idea of a locked in monthly repayment, then a fixed rate loan is good. But remember that there can be issues down the track.

So, always check the comparison rate to find out what extra charges and issues could go with your loan. It’s not hard if you show some interest in the interest you’re going to have to pay.

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