A lot of borrowers see a headline rate and think wow! That’s much better than my current loan.
The issue is that these headline rates can be misleading. Things like
- account keeping fees
- annual fees
- introductory rates
- fixed rates that then convert to a horrible variable rate after the fixed term
can all be used to hide the real cost of a loan.
As an example, on a $250,000 loan, a typical $395 annual fee is equivalent equates to a rate increase of 0.158% (or that amazing 2.5% becomes 2.658%). Still a good rate, but not exactly what was offered!
A comparison rate translates these types of things into the equivalent value, so it gives you a better ability to compare. The comparison rate is calculated on a $150,000 loan over a 25 year term.
Comparison rates on loans are supposed to help you compare different types of loans, so that you get an overall picture, and are designed to take into account these types of things. So, a loan that says interest rate 2.5%, but comparison rate 3.2% is telling you something – you need to look at the fine print to see what else you are paying over the life of the loan.
But comparison rates aren’t perfect. Comparison rates are ONLY valid for the specific “scenario”, so they aren’t a like for like comparison. A borrower with a larger loan, or a shorter term would typically see less movement from the headline rate. Still, a much larger comparison rate should be a flag that says “Borrower beware!”.
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