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The banning of exit fees means comparison rates will give a better guide to the cost of a mortgage.

Home-loan comparison rates will give borrowers a better idea of the all-up cost of their loan, following the passage of legislation last month banning mortgage exit fees.

So-called back-end charges, such as deferred establishment fees, early termination fees and exit fees, have not been included in comparison rates (because they are not paid by all borrowers) and this has raised questions about their reliability. Now many of those fees will no longer apply.

Comparison rates, also called average annual percentage rates, combine interest rates and fees to give borrowers a picture of the total cost of a loan. They have been available on websites such as Canstar Cannex and InfoChoice for many years and, in 2003, lenders were required to distribute them with loan application documents.

That requirement was removed with the introduction of national credit law in 2009 but if lenders advertise a rate, they must still show the comparison rate.

Consumer finance websites still feature them in their interest rate tables.

Comparison rates have always had their critics, who argue that the rate is based on a formula that only looks at a specific loan profile (see box). They have also argued that because they do not include the back-end fees, they can be misleading.

An amendment to the National Consumer Credit Protection Act was passed on March 23, banning exit fees on all home loans sold after July 1 this year. The ban applies to fees payable on the termination of the loan.

The ban does not cover break fees for early repayment of fixed-rate loans or discharge fees that reimburse the lender for reasonable administrative costs of terminating the loan contract.

The ban does not apply to loans that are not secured by residential property. Exit fees in credit contracts entered into before July 1, 2011, will still apply.

ONLY A STARTING POINT

A partner at Gadens Lawyers, Jon Denovan, says that because back-end fees such as deferred establishment fees were optional or contingent, they were never included in comparison rates. “With a lot of those fees now banned, the comparison rate will be a better guide,” he says.

Denovan says borrowers still need to take care with comparison rates, however. “There are still some optional fees that are not included,” he says. ”They include redraw fees and administrative charges for handling one-off repayments. The other thing to remember is that the comparison rate will not include current discount offers or fee waivers.”

Denovan says borrowers should watch this space. A number of lenders have applied to the Australian Securities and Investments Commission for exemptions.

“A borrower might have taken out a shared equity mortgage that pays the lender half the capital gain when the loan is paid,” he says.

”Under the law, that is an exit fee. We would expect to see an exemption for that type of arrangement. What if the lender has offered to waive the cost of lender’s mortgage insurance (LMI) as long as the loan is held for a certain period? The borrower then pays out the loan before that period elapses. If the lender has paid the LMI for the borrower, it is appropriate that it can recover its costs.

“We think ASIC will allow lenders to charge an exit fee if a borrower pays out the loan before a honeymoon interest rate period ends,” he says.

An analyst with InfoChoice, David Lalich, agrees that while comparison rates are a useful tool, borrowers need to take care. “There is a danger [that] comparison rates will lead some consumers to oversimplify their loan choice and not look beyond the price of a loan to the suitability of features,” he says. “A comparison rate only looks at pricing. It does not take into account the value of features such as repayment flexibility, redraws and offset accounts, which … can reduce costs significantly.”

What goes into a comparison rate?

???????????????????????? Lenders must base their home-loan comparison rates in advertisements on a $150,000 loan with a 25-year term.

???????????????????????? Car-loan comparison rates are based on a $30,000 loan with a five-year term.

???????????????????????? Applications fees, valuation and legal fees and other upfront charges are spread out over the term and given an annual value, which is added to the interest rate.

???????????????????????? The comparison rates does not include any government charges that may apply to the loan contract, such as stamp duty or mortgage registration fees.

???????????????????????? Credit providers are not required to provide a borrower with a comparison rate for their particular loan amount and term. Some may be willing to do so if asked.

???????????????????????? The comparison rate does not take into account product features, such as fees on a transaction account sold with a home loan package or the value of savings available through flexible repayment arrangements. Borrowers need to take these into account.


Posted by John Kavanagh – The Age on 6th April, 2011