Choosing to refinance or repay a home loan during its fixed rate period often means the lender will charge you a break fee. The cost of this fee will vary based on how long is left on your fixed rate term and how much interest rates have changed since you applied for the loan. With break costs reaching tens of thousands of dollars in some cases, they may affect the overall value of your refinance.
How much does it cost to break a fixed mortgage?
How do break fees work?
When you apply for a fixed rate home loan, you agree to pay a fixed amount of interest for a predetermined length of time, often between one and five years. If you break this contract, you may be required to pay break fees to help make up for the lender’s losses.
You could break a fixed rate home loan by:
- Refinancing your home loan (with the same lender or a different lender) before the end of the fixed rate period
- Making extra home loan repayments in excess of an accepted amount during the fixed rate period
- Repaying the loan in full before the end of the fixed rate period (such as when you sell the property)
Why do banks charge break fees?
Break fees are intended to make up a lender’s financial losses when they miss out on the interest charges they’d previously budgeted for when you agreed to a fixed rate loan. As such, the exact total you’ll pay may vary depending on the exact circumstances of the break from the loan.
When a bank provides a fixed-rate loan, they borrow money from wholesale money markets using the Bank Bill Swap Rate (BBSR), which is locked in at the same time as your interest rate.
If you break your fixed rate contract early, your lender will still need to pay off its own loan by re-lending money to another customer. If the BBSR has fallen between when you fixed your rate and when you broke your loan, the bank’s finances will come up short, and they will pass this shortfall on to you as a break cost.
Do break fees always apply?
If fixed interest rates have risen in the time between when you first applied for your loan and when you broke the contract, it’s possible you may pay a lower break fee or even no break fee at all.
This is because the lender may be able to make more money by re-lending the money from your loan to another customer, so there’s no real financial shortfall to make up.
How much is a break fee?
A break free is not a fixed amount, and may not be easy to calculate in advance. This is because there are several factors that go towards making up your break fee, such as the:
- Loan’s total loan term
- Time left on the fixed rate period
- Total value of your loan
- Interest rate that you fixed at
- Lender’s current fixed rates being offered to new customers
The wholesale interest rate or BBSR is also an important factor, though this rate is commercially sensitive and is not displayed publicly.
According to BOQ a simplified break cost formula goes:
Break Cost = Loan amount prepaid x (Interest Rate Differential) x Remaining Term
- A loan amount of $300,000 is fixed for 3 years and then is entirely repaid by the customer with 1.5 years of the loan’s original fixed term remaining.
- The 3-year wholesale rate on the date the loan was fixed was 3.45% p.a. but the rates have fallen since then. The current 1.5-year wholesale rate when the contract was broken was 2.23% p.a.
- The difference between the wholesale rates on the date the loan was fixed and when the contract was broken is: 3.45% less 2.23% = 1.22% Interest Rate Differential.
- The approximate Break Cost would therefore be: $300,000 x 1.22% x 1.5 = $5,490
- This figure is then discounted to provide a net present value as at the date of the break.
This is only one example. The only way to know for certain what you’ll need to pay when you break a fixed rate home loan is to contact the lender and ask for a break cost quote. They can perform the necessary calculations and give you a figure, though this may vary if your circumstances change.
Keep in mind that by contacting your lender and asking about exiting a loan, they may be willing to negotiate to keep your business. Depending on your circumstances, this could even make it more worthwhile to stick with your current lender than to switch.
Is it a good idea to refinance a fixed-rate mortgage?
When considering whether it’s worth refinancing a fixed-rate mortgage, assessing your circumstances and reasons for refinancing is important. Thanks to the potentially high cost of break fees, refinancing from a fixed rate home loan may not always be worth it. However, the break costs may be lower if you refinance later in your fixed rate term, which may make them easier to budget for. It's crucial to weigh all factors before making a decision.
If you’re experiencing FOMO (fear of missing out) on lower rates, you may want to refinance from your fixed rate. If your only aim is to secure a lower interest rate, remember to compare the costs and potential savings to ensure that the lower rate will actually benefit you. Even if you switch to a home loan with a lower interest rate, it may be a long time before the interest savings make up for the higher switching costs.
Refinancing a fixed-rate loan during the fixed period is often more expensive than refinancing a variable-rate loan, due to the break costs involved. However, if interest rates are rising, it may be worth refinancing to find a lower rate.
For example, if the fixed term on your loan is ending in the next few months and your bank's revert rate (typically the standard variable rate) is too high, you may want to refinance to get a lower rate. But if interest rates continue to rise and property prices fall, you could end up owing more than your property's worth, making it challenging to refinance.
To avoid this situation, you could consider breaking your fixed term early and locking in another fixed rate before the interest rates rise further. While you may need to pay extra to exit your fixed loan early, locking in a new fixed rate before any more interest rate rises could help you save money in the long run. But this may only hold true for some, as everybody's situation is different, and you need to compare your costs and savings before selecting the most appropriate option for your circumstances.
A mortgage broker may be able to help calculate what break costs you can expect, and how long it may take for interest savings on your new loan to make up these extra costs.