How much does it cost to break a fixed loan?

Ending a fixed rate home loan period before the agreed time is certainly possible but before you jump, you’ll need to understand what fees and charges you could face.

What are break fees?

So-called ‘break fees’ are charged if a fixed rate home loan is repaid before the end of the fixed period. This might happen when a borrower chooses to refinance to another loan, typically one with a variable rate, or decides to sell their property.

Break fees are charged because the lender will have calculated how much it will earn from your mortgage based on your interest rate, and possibly other home loan fees, assuming you’ll make your repayments until the end of the fixed rate period.

It will have weighed up what it expects to earn from you repaying your home loan against the cost of providing you the funds used to purchase your property. Lenders often turn to the wholesale finance market to get the money to finance fixed rate home loans, meaning your lender might also be paying interest to borrow the funds it lent to you – albeit at a lower rate.

If you choose to end your fixed rate period earlier or alter your repayment schedule in some way, it’s possible the lender could make a loss, or that your loan won’t be as profitable for your lender as it had expected.

Break fees are how lenders pass on any losses it realises because a borrower reneged on a fixed rate agreement.

Are break fees charged on variable rate home loans?

It’s very rare for a variable loan to be subject to break fees, although some lenders do charge fees to refinance.

While you may be up for an exit or discharge fee for ending a variable rate loan, you generally won’t be charged break fees.

How are break costs calculated?

There are several variables when it comes to calculating break fees. Many of them depend on the lender and the specifics of the loan taken out.

Some of the factors may include:

• How long you’ve held the loan

• How long remains on your loan contract (generally the more time left, the higher the break cost)

• The total value of the loan (generally the higher the loan amount, the higher the break cost)

• The interest rate that you fixed at

• The current fixed rate at the time you’re looking to break your loan

Break fees are not a flat fee, so if you’re thinking of ending a fixed loan, you’ll need to speak to your lender to understand how it will calculate how much you’ll have to pay.

You should do this before you decide to break your fixed rate home loan, as the cost could be significant and wipe out any savings you stand to make by switching to a new loan if you’re thinking of refinancing.

Bear in mind, you may also have to pay break costs if you:

• Make extra repayments beyond any agreed cap or limit

• Sell your property before the fixed period ends

• Pay off your home loan early

Using market rates to calculate break costs

Before we get into formulas and figures, let’s consider how your lender has likely funded your home loan – on the wholesale finance market. It typically will have done so with a fixed end date (or maturity date).

This is where things can get technical.

If you switch loans or pay out your loan early, your lender will use what’s called the Bank Bill Swap Rate (referred to as BBSW) to calculate your break fees.

The BBSW is a short-term rate used in financial markets as a lending reference rate over specified time periods. This is subject to daily changes, meaning break costs can also vary day by day.

Your lender will work out how much you breaking you loan will cost it, according to the BBSW, on the day you break it.

For instance, if you’re exiting a three-year fixed rate home loan a year early, your lender will look at the three-year BBSW on the day you took up your loan compared to the one-year BBSW on the day you break it.

If the repayments the lender can get by re-lending that money to someone else is less than what you would have paid had you kept up your end of the agreement, then you will be up for the shortfall.

The maths behind break costs

Here’s a very simplified equation demonstrating how break fees might be calculated, bearing in mind that various lenders have various ways of calculating break costs:

So, let’s say you have $300,000 left to pay on a three-year fixed rate of 5% p.a. interest, and you wish to break it with one year to go. In that time, the interest rate for a one-year fixed rate loan has dropped to 3% (2% p.a. lower than it was when you signed on).

In such a circumstance, the equation might look like this:

Thus, a $6,000 break fee might be passed on to you, in addition to potential exit fees and other penalties.

BUT… what happens if interest rates have gone up since you took the loan out?

In that case, your lender might stand to make money by re-lending the funds to another borrower at a higher interest rate.

In such cases, you likely wouldn’t be charged for any interest shortfall but would still be up for exit fees and possibly some form of penalty to cover administrative and paperwork costs.

How can you avoid break costs on a fixed loan?

It’s not always possible to dodge break costs if you have to end your fixed rate period early, but here are some points to consider:

Think carefully before taking out your loan

The best way to avoid paying break costs is to make sure you’re doing the best thing by locking into a fixed rate in the first place.

Every borrower’s circumstances and needs are different so there is no right or wrong choice between fixed and variable home loan interest rates. However, it’s wise to imagine where you see yourself over the term of the fixed rate period.

Ask yourself whether you may need some flexibility built into your home loan and weigh up the alternatives of a fixed rate, a variable rate, or a split rate.

No one can see what the future may bring, but putting research and thought into your home loan in the first instance can set you on the right path to avoid break fees down the track. So, if you’re thinking about moving away, flipping your property, or you expect interest rates to fall, fixing your rate likely won’t be the best decision.

Stay the distance

Another sure way to avoid break fees is to see your fixed rate term out before making any changes to your home loan.

Of course, this won’t always be possible, such as when you’re selling your home or you’re paying your home loan off early for other reasons. In such cases, you’ll likely have little choice.

But if you’re looking to swap over to a home loan with a better interest rate or more suitable features, make sure you do your calculations as to whether it will be worth the switch once break fees are factored in.

Ask your lender about loan portability

Loan portability is another factor you should think about before signing up to a home loan, particularly a fixed rate home loan.

Loan portability is a feature offered by some lenders that might allow you to keep your home loan intact even if you sell your property, meaning you won’t have to refinance if you buy another home.

Loan portability is sometimes referred to as a ‘security swap’, meaning the lender will simply swap the property that’s acting as security for your loan.

One downside of this feature, though, is that you're still bound to the same lender and there are usually fees associated with the swap.

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