A fixed rate home loan can be a great way to protect your finances against any interest rate hikes, allowing you to confidently organize your budget around your monthly repayments.
But your circumstances may change, and over time you may find that being locked into a fixed rate is no longer for you. Some of the reasons you might want to break your fixed rate contract include:
- Your home loan is not working for you and you want to refinance
- Want to sell your property
- You want to repay part of your loan early
- You are able to repay your loan in full early
Although your bank won’t prevent you from doing these things, you might find the process isn’t exactly straightforward. Below, we take a look at what you can expect when you break a fixed rate before the end of your term.
Will I pay break fees?
When you take out a home loan, your bank funds it with money borrowed from the wholesale money market. It is the network that facilitates high-volume trade between financial institutions and governments.
If you decide to fix your loan, your bank will also fix its financing costs to protect against any interest rate hikes. Leaving your CDD prematurely is a major disruption for your bank, as it still has to repay the money it owes in the wholesale market.
If interest rates have changed since your loan was funded and your bank incurs a loss, they will recoup it by charging you a fee. This is commonly known as breakage fee or breakage cost, but some lenders may also use terms such as prepayment penalty.
This can be tens of thousands of dollars, so be sure to discuss your options with your lender before breaking the fixed rate agreement.
How is the break package calculated?
If your lender suffers a loss as a result of dropping your fixed rate contract, they will pass the costs on to you in the form of high fees. But the amount of fees varies from customer to customer.
Some of the things your bank will take into account include your loan balance as well as the time remaining on your fixed rate term.
It will also take into account the swap rate difference, i.e. where the rates were in the wholesale market on the day your loan was funded and where they are when the fixed rate agreement is terminated.
All of the above factors can be condensed into the following formula:
Outstanding Loan Balance x Time Remaining on Fixed Term x Swap Rate Difference = Break Fee
Just keep in mind that swap rates fluctuate daily, so if you ask your bank for a quote one day, it could be very different the next.
Example of a fixed rate severance payment
Sarah borrows $500,000 to buy an apartment, and to help her budget, she decides to fix her loan for five years. To finance his loan, his bank borrows on the wholesale market at a rate of 5% per year
Three years later, Sarah decides to sell her property. She repaid $75,000 on her loan, leaving her with an outstanding balance of $425,000.
Since Sarah’s loan was funded, the wholesale market rate has fallen to 2% per annum. But its bank’s funding costs remain set at 5% per year. This means that her bank will lose money by allowing Sarah to breach her contract.
In this scenario, the break fee calculation formula would look like this:
$425,000 x 2 years x 3% = $25,500
The final number will be a little different once Sarah’s bank adjusts the present value, as well as her repayment type (whether she paid principal and interest or interest only), but she can generally expect that whether it is within this range.
Should I terminate my fixed rate contract?
It may be tempting to ditch your current loan in favor of a better loan, especially if interest rates have fallen since the start of your term. But it’s still possible that the penalties incurred outweigh the savings from the change.
Ultimately, the decision will depend on you and the particular circumstances you find yourself in, but as always, it’s a good idea to explore all of your options with your lender or an independent financial adviser.
Looking to take out a home loan or refinance your existing loan? Visit our home loan comparison page, where you can filter your search by rate and type.
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ATTENTION: This comparison rate only applies to the example or examples given. Different amounts and durations will result in different comparison rates. Costs such as withdrawal charges or prepayment charges, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate shown is for a secured loan with monthly principal and interest repayments of $150,000 over 25 years.
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Initial monthly repayment figures are estimates only, based on the advertised rate, loan amount and term entered. Rates, fees and charges and therefore the total cost of the loan may vary depending on the amount of your loan, the term of the loan and your credit history. Actual repayments will depend on your personal circumstances and changes in interest rates.
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