When comparing loans, it's easy to focus on one number: the interest rate. But the interest rate isn't necessarily the amount your loan will actually cost you.
A more useful question is: How much money will leave my pocket between the day I borrow and the day the loan is completely repaid?
That figure can include interest, establishment fees, ongoing account fees, valuation fees, government charges, lender's mortgage insurance (LMI) and other costs depending on the loan. Understanding the true cost of borrowing can help you avoid choosing a loan that looks cheap but costs considerably moreover time.
Start with the loan amount and term
The basic calculation begins with three numbers: how much are you borrowing, what is the interest rate, and how long will you take to repay it?
For example, suppose you borrow $500,000 over 30 years.
Even a relatively small difference in interest rate can make a substantial difference over three decades. This is why comparing a loan based solely on your monthly repayment can be misleading. A longer loan term may reduce your monthly repayment while increasing the total amount of interest paid.
Understand principal and interest
With a principal-and-interest loan, each repayment generally consists of principal (paying down the amount you borrowed) and interest, the lender's charge for providing the money. Early in a long loan, a larger proportion of your repayment can go towards interest. As the principal reduces, the amount of interest charged generally falls.
Don't ignore the fees
Depending on the loan, costs may include application or establishment fees, annual or monthly account fees, valuation fees, settlement fees, package fees, early repayment fees, break costs on some fixed-rate loans and other administration charges. Stanford recommends looking at the interest rate, comparison rate, application fees, ongoing fees, loan term and loan features when comparing loans.
What is a comparison rate?
A comparison rate is designed to make comparing the cost of loans easier. It combines the interest rate with most fees and charges into a single percentage figure.
For example:
- Loan A: Advertised rate 5.90%, comparison rate 6.15%.
- Loan B: Advertised rate 6.05%, comparison rate 6.10%.
Although Loan A has the lower advertised interest rate, Loan B has the lower comparison rate.
That doesn't automatically mean Loan B is right for you, because comparison rates are based on particular assumptions and may not account for every cost or feature relevant to your circumstances.
Calculate total interest
For a simple example, imagine a $500,000 loan over 30 years at a constant 6% interest rate. Your repayment would be approximately $2,998 per month.
Over 30 years, you could make total repayments of approximately $1.079 million.
That means roughly $579,000 would be interest. And that's before considering other loan-related costs. This demonstrates why a loan should be assessed over its entire life, not just by asking: "Can I afford the monthly repayment?"
The better question is: "What will this loan cost me altogether?"
Consider the features
The cheapest loan on paper isn't necessarily the most valuable. Consider an offset account.
If you have $50,000 sitting in an offset account against a $500,000 mortgage, interest may be calculated on a lower effective balance, depending on the loan structure. Similarly, additional repayment facilities can help some borrowers reduce interest over time. But features can come with higher fees.
So the calculation becomes: potential interest saving minus additional fees equals potential net benefit.
Stress-test the loan
One of the most important calculations isn't based on today's interest rate. It's based on tomorrow's.
Ask: What happens if my interest rate increases by 1%?
Then: What happens if it increases by 2%?
And: What happens if my income temporarily falls?
We recommend considering whether you could still afford a variable loan if rates rise by 2% or 3%.
Use a calculator before making a decision
The easiest way to understand the numbers is to model different scenarios.
The Stanford Financial Calculators can help you explore borrowing and repayment scenarios before you commit to a particular loan. You can then take those numbers into a conversation with a lending specialist.
Stanford Financial takes a personalised approach to lending, assessing your circumstances and comparing suitable finance options across a broad lender panel.
The real cost is more than the rate
When comparing loans, look at:
Interest rate + fees + loan term + features+ repayment structure + flexibility = the real borrowing decision.
The cheapest advertised rate might be the right answer. But it might not. The smartest borrowing decision is the one based on the total cost and how the loan fits your financial life.
General information only. Your lending options depend on your individual circumstances, lender criteria and applicable laws.
Credit. Stanford Financial Pty Ltd ACN 641 775 242 is authorised under Australian Credit Licence 541480.
