Understanding home loan break fees

Looking to repay your fixed rate home loan sooner or switch to a better variable rate? There may be fees involved, specifically break costs.

What are break costs?

Break costs are a fee charged by your home loan lender if your fixed rate home loan is repaid before the end of the fixed rate period. This fee is also charged if you choose to switch to another loan type - from fixed to variable - before the end of the fixed rate period.

Typically when a lender decides to lend you money at a fixed interest rate, they obtain money from the market at wholesale interest rates, based on your ability to make repayments as agreed upon until the end of the fixed rate period.

By moving this period forward or altering it completely, the lender has the potential to make a loss as wholesale interest rates change. The break costs fee is used by lenders to pass on the actual loss incurred when you pay off a fixed rate loan or switch earlier than anticipated.

Are break costs charged on variable rate home loans?

Generally, if your home loan is structured with a variable rate, you are usually able to avoid a break costs fee, however this differs from lender to lender. Break costs fees only relate to fixed rate home loans, if you were to pay off your variable rate home loan earlier or switch to another lender, you may be charged an exit or discharge fee.

How are break costs calculated?

To calculate the amount of the break costs, lenders will typically multiply the difference in wholesale interest rates with the remaining term in your fixed rate period and the average loan account balance that would have applied during that time.

Put simply, Break cost = Loan Balance Owing x Interest Differential x Remaining Fixed Period.

For example:

James has a loan balance of $300,000 with a fixed rate of 5.00% p.a. for 5 years, which is repaid after 2 years. The time remaining for his fixed rate term locked in is 3 years and the current 3 year fixed rate is 4.00% p.a.

• Break Cost fee = $300,000 x 1.00% x 3 years
• Break Cost fee = approximately $9,000

Can break costs be avoided?

If you are looking to break your fixed rate home loan contract, you will be required to pay break costs. The way to avoid this could be to see out the loan term before switching. If you are in the market for a home loan, ensure you consult your lender prior to signing on the dotted line with regards to what break fees are associated with its home loan products.

If you are in the market for a competitive fixed or variable rate home loan or simply want to learn more about the break costs that may apply to your loan, chat to one of our lending specialists today.

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