Breaking a fixed-term mortgage usually incurs break fees. These fees vary, so understanding your break fees is vital when deciding to change your mortgage.
What are break fees?
When you lock in a fixed rate with a lender, you enter into a contract. This contract specifies that you’ll pay a set interest rate for a certain period, usually between one to five years. A break fee is charged when you alter or repay a fixed-rate mortgage before the agreed term.
If you were to change mortgage provider, that would be considered a repayment of your current mortgage, with the new provider paying off the current mortgage.
Why do break fees exist?
When you agree to a fixed-rate loan, you’re locking in that interest rate for the duration of the term. While administration costs are incurred by the lender when a fixed-term loan is broken, there can also be a profit cost. If interest rates drop and you want to break your fixed-term loan, the lender can’t lend that money at the original rate. This leaves the lender at a financial disadvantage. This is why they charge a break fee to compensate for that loss. In a market where rates are falling, this can result in a significant break fee.
Here’s an example:
Let’s say you lock in a fixed rate of 6.8% for 12 months, but after six months, the interest rate drops to 6%. If you break your fixed term and repay the loan early, the lender will have to loan out that money at the current 6% rate. This leaves the bank making 0.8% less in interest.
The break fee is, in part, calculated based on the difference between the rate you’re paying and the new lower rate, as well as the length of time remaining on the fixed term. The higher the loan amount, the larger the difference between the fixed rate and the current market rate, and the longer the period left in the term, the higher the break fee.
What you should know before breaking a fixed-term loan
Break fees aren’t just calculated by the difference in interest rates. Lenders also factor in wholesale rates (the rates at which they acquire funds) and other relevant factors. Because of these complexities, the break fee may differ from your own calculations. Therefore, requesting a quote from your lender before deciding whether to break your loan term is essential. If you use a Platinum Mortgages mortgage adviser, we can request a quote on your behalf.
Should you break your fixed loan for a better rate?
In a market where rates are falling, you may be tempted to break your fixed-rate loans in favour of a lower interest rate. It may pay to do so, but you can only determine whether you will save money once you know the break fee. The break fee and any other associated fees could outweigh the savings from the lower interest rate.
Be strategic as your fixed-term accounts mature
At the time of writing, further interest rate cuts are expected. So, as a fixed-term rate matures, you may decide to stay on a floating rate for the time being, waiting for further interest rate cuts from the Reserve Bank. This approach can pay off but is a gamble, as floating interest rates will be higher than refixing. But it’s a decision some are willing to make in the hope that they will save money in the long run when they lock in a lower interest rate further down the line. Another option is to fix for a shorter period.
Talk to us when your fixed-term accounts are due to mature; we can help you understand the market and your options.
Break fees aren’t set in stone
Break fees aren’t static. They can change daily, just as floating interest rates can change daily. Additionally, fluctuations in the wholesale market can also impact break fees. This means the fee you’re quoted today might not be the same tomorrow. It’s vital to get a quote in writing and to know how long it will remain valid.
Moving home? Consider transferring your fixed rate
If you’re selling your property and buying a new one, you may be able to transfer your fixed-rate loan to your new home. This can save you from paying a break fee altogether. However, not all lenders offer this option, so confirm this possibility with your lender before making any moves. This is especially important if you’re relying on your current fixed rate when budgeting for the new home. If you work with a mortgage adviser, we will work directly with your bank to identify your options.
Get the right advice about break fees
Break fees are complex. Before making any decisions about your mortgage, it’s best to consult with a mortgage adviser. We can help you understand the implications of breaking your fixed term and ensure that you’re making a choice that suits your financial situation and long-term goals.
If you’re considering breaking your fixed-term loan or want to learn more about how break fees could affect you, contact us at Platinum Mortgages. Our experienced advisers can guide you through your options, answer your questions, and help you make the best decision for your financial future. We then work with lenders on your behalf so you can take that off your to-do list!