Thinking of getting a home loan? Maybe it’s time to get one as you prepare for your future. And once you’ve decided you’re buying a home, you’ll need to search for the ideal home loan option for you. This can be one of the biggest financial moves that you’ll be making in your life so you wouldn’t want to make serious mistakes around this area.
Understanding the overall cost of your loan is critical to ensure that you know what you’ll be paying. In this way, you’ll be aware of how to prepare your finances and that you’re getting the best deal. Besides, getting a loan is a long-term commitment. So, even if there’s a slight difference in interest, it does add up over time.
As you start your research, you’ll be surprised by various banks and lenders that are willing to lend you. This can be unnerving and may get confusing as you get different loan types from lenders. If you’re a first home buyer, it’s easy to get overwhelmed with the process and information you need to understand.
It’s always ideal to talk to the expert when you’re not familiar with the process. DDDC Finance can help you in narrowing your best loan option based on your finances and goals.
Advertised Rates vs. Assessment Rates: Know the Difference
So, let’s start with understanding the two important terms that you’ll surely encounter when you apply for a loan. These are the advertised rates and assessment rates. It’s critical that you know the difference between Advertised Rates vs. Assessment Rates as they are factors related to your loan.
What are Advertised rates?
Many people are confused about the interest rate they are paying when they get a loan. One of the reasons is that they look at the advertised interest rate instead of the actual interest rate.
Advertised rate is the stated rate applied on your loan without considering any fees or compounding of interest. Note that this doesn’t take into account inflation yet. And in most cases, this is rarely the interest rate that you’ll end up paying.
Advertised rate is a percentage rate and each month, it’s multiplied by your remaining loan balance and is charged as “interest” on your loan. However, this rate isn’t equal to the total fees and charges applied to your loan. It only gives you a part of the costs of the loan.
What are Assessment rates?
Every lender has their own standard variable interest rate which they can apply to their home loan products. You might think that this is the rate that lenders will use in calculating how much you can borrow. But that’s not actually the case.
What lenders use is the rate that is higher than their variable rate. This is to take into account in case there will be an increase in interest rate in the future. We call this rate the assessment rate or floor rate.
The standard variable rates of each lender are calculated based on the cash rate set by the Reserve Bank of Australia (RBA). When you apply for a home loan, lenders will add 2% or 3% on top of their standard variable rate to assess your application. They will then use this floor rate to calculate your serviceability or capacity to pay the loan.
Assessment rates work best for both the lenders and the borrowers. This will cover you and the lender in case there’s an increase in the RBA’s cash rate.
If there will be a future increase in cash rate, this means you’ll pay more on your monthly interest. Of course, it also works the other way. You’ll pay less when the cash rate decreases and if your lender will lower their interest rate.
By having an assessment rate, lenders get an assurance that they can cover the costs of providing the loan and still make a profit. On the side of the borrower, you can think of this as a protection of your financial future. Lenders use the assessment rate to make sure that you can make the repayments or serviceability even if there will be future changes.
Assessment rates are not known by the general public. This is because banks don’t usually advertise them. And not all lenders use the same serviceability test and floor rates buffer. So, you have to look around and compare home loan options carefully.
Best to consult with a professional for advice when it comes to finding the best home loan deal for you. Our team in DDDC Finance can help you with the process and also find the most appropriate deal that matches your financial needs.
How Can Assessment Rates Affect Your Application?
Assessment rate assumes that you can pay more than you will for your loan. Your application may get rejected if your income can’t cover this extra interest. The minimum buffer of interest rate was recently increased to 3% by the Australian Prudential Regulation Authority (APRA).
This buffer is added to the interest rate of the loan. The borrowers are then assessed whether they can repay the loan together with the buffer. APRA also stated that the minimum assessment rate must be 7%.
This means that your application will be assessed under the presumption that you will pay at least 7% interest on your loan. This may be a problem for those who have existing debts or other loans. Assessment rates can either make or break your loan application. But this is a helpful factor that can both protect you and the lenders in the long run.
Aside from assessment rates, there are other factors that can have an impact on your home loan application. It can be the current interest rate and even how lenders see your financial situation. And let’s not forget the confusing computation involving advertised rates and the actual interest rates.
However, the process of applying for a loan doesn’t need to be confusing and overwhelming. By knowing and understanding the process, you can get the best deal for yourself. It’s just necessary that Advertised Rates vs. Assessment Rates are differentiated clearly in your mind so you’re guided.
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Sources:
[1] Uno Home Loans. (2021, November 11). Explaining assessment rates.
[2] Miller, S. (2018, October 9). What’s A Loan Assessment Rate??. LinkedIn.
[3] Nickolas, S. (2021, May 11). Real vs. Nominal Interest Rates: What’s the Difference? Investopedia.
[4] Positive Lending Solutions. (2018, May 16). Advertised vs Comparison Rates.
[5] Home Loan Experts. (n.d). What Is An Assessment Rate?
[6] APRA. (2021, October 6). APRA increases banks’ loan serviceability expectations to counter rising risks in home lending.