As mortgage rates creep up, borrowers will naturally look to ‘comparison rates’ to help decide their next move. But even those numbers should be handled with care.
‘Comparison rates’ are one of the key decision-making tools available to help you find the best deal possible on a home loan. They add the major fees associated with a mortgage to the headline interest rate – supposedly to reveal the ‘true’ cost of a loan.
Just knowing that definition will put you ahead of the pack. A recent survey found that 74 per cent of Australians did not even know what a comparison rate was.
Knowing how to properly use comparison rates will become even more important because we can expect to see more out-of-cycle rate hikes in the months ahead.
The early warning sign was when Suncorp announced on March 23 it would raise mortgage rates by between 0.05 and 0.08 percentage points.
While the Reserve Bank won’t be lifting official interest rates any time soon, Suncorp’s decision is a reflection of a squeeze being felt by all banks.
Roughly a third of Australian mortgage debt is sourced in overseas wholesale markets, where borrowing rates are creeping inexorably higher.
The question for mortgage holders is what to do about it, and in particular whether to swap to a cheaper mortgage provider if they see their current rate getting too high.
This is where comparison rates come in.
For example, Bank of Queensland is currently pricing its standard variable mortgages at 5.61 per cent, which equates to 5.77 per cent when all fees are accounted for – and by law both figures must be published when it’s advertising its loans.
For its ‘First Start’ loan, which comes with a 12 month rate discounted by 0.01 percentage point, BoQ charges 5.01 per cent, or more like 5.77 per cent with fees included.
Truth is relative
So the comparison rate looks pretty reassuring to the financial novice trying to work out where to switch their home loan next.
But don’t be too reassured, because even this measure of the ‘true’ cost of your mortgage can be quite deceptive.
For starters, lenders are required to follow a formula set down by the corporate regulator, the Australian Securities and Investment Commission, to ensure all comparisons are on a true ‘like for like’ basis – and that formula itself is looking a bit rusty.
It models loans of $150,000 over a 25 year period, when in fact the average mortgage today is just under $400,000, written for a 30 year period – and refinanced, on average, every five years.
Then there is the issue of what you want to do with the loan.
For instance, a young buyer might want to live in a flat in Perth for a few years while they study, and then rent it out and move to Sydney to work a few years later.
Officially, such a borrower would have to close down one mortgage (incurring a registration fee of $115), take on an investor mortgage (another $115), and pay higher ‘investor’ interest rates.
It is common, therefore, for people to just avoid telling their bank that the purpose of the loan has changed, and that is most easily done if the loan is attached to an ‘offset account’.
The offset account allows an owner to make random-sized repayments into a side account, rather than paying down the linked mortgage, so the bank never has a clear picture of whether they are getting ahead or treading water.
The same borrower might also want a package of benefits, such as a debit card linked to the same offset account, a facility allowing them to redraw anything extra that has been paid off the mortgage, or the ability to pay down their loan more quickly than expected without paying penalties.
A ‘package fee’ for all those extras can come in at around $350 a year, and that could be added to during the year with one-off fees for unprocessed payments (when you account is empty) or the cost of switching the same loan in or out of ‘interest-only’ mode.
Pretty complicated, huh? That’s why the overall comparison rate should be seen as a rough guide only.
It’s up to the borrower to put their own particularly borrowing needs, and repayment habits, down on paper and try to estimate what the ‘true true’ cost will be – especially in relation to life-stage issue such as having kids, going part-time to raise kids, moving up to a bigger home and the like.
A loan that is structured the right way, and with the right features, could end up costing you less that one that simply boasts the lowest comparison rate – something to remember the next time a lending manager whispers in your ear that they have the cheapest rates in town.