What is a fixed term loan
What are break costs?
Break costs are fees charged by lenders when you make extra repayments on a fixed rate home loan.
Most lenders will allow you to pay a small amount off of your mortgage each year without being charged but if you go over this amount or pay off the loan entirely then you will be charged break fees.
Banks do not always disclose their break fees or how they will be calculated! For this reason we’ve created this easy to follow guide for anyone considering a fixed rate loan.
Use the break costs calculator to estimate your exit fees.
Did the government ban exit fees?
All variable mortgages advanced on or after the 1st of July 2011 have no early repayment penalties or exit fees. However, fixed rate break costs and discharge fees still apply.
If your home loan is fixed or if it was setup before July 2011 then you may still have significant exit fees.
Every home loan has a small discharge fee (typically $350 per property) which covers the cost of the lender removing the mortgage that has been registered on the title of your property.
This fee is reasonable as it is an actual cost incurred by the bank and, consequently, discharge fees were not banned by the government.
How much can I repay without break fees?
That depends on which lender you’re using! The major banks are relatively inflexible with extra repayments on their fixed rate home loans but some building societies offer flexible fixed rate loans which allow unlimited additional repayments:
- Commonwealth Bank (CBA ): $10,000 per annum.
- National Australia Bank (NAB ): $20,000 during the fixed rate term ($0 for some loans).
- Westpac (WBC ): $30,000 during the fixed rate term.
- Australia and New Zealand Bank (ANZ ): $5,000 per annum OR 5% of the original loan amount, whichever is the lesser.
- St George Bank (SGB/StG): $10,000 per annum.
- Rams: $30,000 during the fixed rate term.
- Suncorp: $499.99 per month more than the normal monthly repayments.
- BankWest: $10,000 per annum.
- Specialist fixed rate lenders: Unlimited additional repayments and redraw as long as the loan account is not closed completely. Please refer to our page about fixed rates with unlimited extra repayments .
IMPORTANT: Banks change their policy from time to time so this information is current only accurate at the time that it was written. You should always check with your lender just to be sure. This information should be used as a guide only.
Be careful if you have a loan with a lender such as NAB or ANZ that does not automatically reduce your repayments.
If you pay off the maximum amount allowable then your next payment may take you over your limit, resulting in the bank charging you bank fees!
You should call your lender to discuss any lump sum repayments you plan to make on your fixed rate loan.
What other names do lenders use for break costs?
Different banks use different names for their break costs. Some common names include economic costs, exit fees, early repayment adjustment or prepayment fees. Often your bank will not know what you are talking about unless you use their terminology:
- Commonwealth Bank (CBA ): Early repayment adjustment (ERA).
- National Australia Bank (NAB ): Prepayment fees and economic cost.
- Westpac (WBC ): Break costs.
- Australia and New Zealand Bank (ANZ ): Early repayment fee (ERF).
- St George Bank (SGB/StG): Break costs.
- Rams: Fixed rate early termination fee & Fixed rate unwind adjustment.
- Suncorp: Early payment interest adjustment (EPIA).
- BankWest: Break costs.
All of these different names refer to the same fees for paying off part or all of a fixed rate loan early.
Why do banks charge this fee?
When a bank funds a fixed rate loan they borrow money from the wholesale money markets. Their interest rate is locked in at the same time as yours.
However, they don’t have the option to repay their loan early so when you repay your home loan they have to lend the money to someone else yet still paying a high rate on their loan from the money markets.
If the cost of borrowing money on the wholesale market has fallen between when you fixed your rate and when you pay off your loan then the bank has an “economic cost” to carry until their loan from the money market is ready to be repaid. They pass this cost on to you as break fees.
What else can cause a break fee to be charged?
You should refer to the terms and conditions of your home loan for the specific situations where you may be charged a break fee. As a rule of thumb, a break fee will apply if:
- You repay the loan in full before the end of the fixed
rate term; or
- You make a repayment in excess of the allowed amount. The allowed amount is the additional payment you can make in a year before break costs may become payable and that amount is set out in your loan agreement with your bank; or
- The total amount owing on your loan becomes immediately due for payment because you are in default; or
- You switch to another loan type (E.g. you switch to a variable interest rate).
Naturally, there must have been a fall in the banks cost of the wholesale funding and you must be on a fixed rate, otherwise break fees will not apply.
How are break costs calculated?
They are calculated by working out the difference between wholesale rates between the time when you applied for your loan and when your loan is repaid and multiplying it by the loan amount and the remaining term of the loan.
There is no exact formula as each lender has their own specific method of working out the fees that they will charge you. The formula used should be listed in your loan contract/loan offer. An example formula would be:
Break fee = Loan amount x Remaining fixed term x Change in cost of funds
Because the term of the loan is used in the calculation, break costs tend to be very high for 10 year or 15 year fixed rate loans and also for larger home loans.
Also, if rates have increased since you fixed your loan then there is a good chance that you will not be charged exit fees for breaking your fixed rate contract because the bank would actually make money from you paying off your loan early!
Some sneaky banks will try to charge you fees anyway, so be careful and ask them how they are calculating the fee or by how much the wholesale market interest rates have changed.
Are the banks ripping us off?
The banks do not tell you what their current costs of funds are, so it is difficult to be sure that they are doing the break fees calculation correctly. We have received reports that some banks are purposely manipulating the break fees that are charged.
They do this by using the difference between the rate that you have fixed at and their current wholesale rate, rather than the wholesale rate when your loan was advanced and the current wholesale rate.
By doing this they can get away with charging you additional break fees without you knowing about it. If you are worried that your bank is trying to rip you off, make a formal complaint and ask them to explain in detail how they are calculating their early repayment penalties.
Should I refinance anyway?
In most cases it is the same cost to refinance your loan and pay the break fees as it is to continue paying a higher rate until the end of the fixed rate term.
For example, if you fixed your loan at 9%, you have one year left on your fixed rate and banks are currently offering rates of 6% then paying a break fee may make you reconsider refinancing.
However, if you are paying a higher rate for the next year, when you do the maths, it usually means that over the next year you pay the same amount in additional interest as you would have paid in a break fee!
For this reason, it normally makes sense to refinance or sell your property if you need to do so but it doesn’t make sense to refinance if you are just trying to save money.
Please call us on 1300 889 743 or complete our free assessment form if you would like to talk to one of our mortgage brokers about refinancing your fixed rate loan.
Example break cost calculation
Example: John has a fixed rate loan of $300,000 with ABC Bank. He fixed his rate at 6% for 5 years. After 3 years John sells his property and repays his fixed rate loan in full. If wholesale interest rates had dropped by 1%, how much would John pay in break fees?
Break fee = Loan amount x Remaining fixed term x Change in cost of funds
Break fee = $6,000 approximately
IMPORTANT: This is an example only. You should refer to your lender for exact break fees. As a general rule, if you had a 6% fixed rate and the lender is now offering 5% fixed rates for the same term, then it is likely that wholesale rates have dropped by 1%. This is not always accurate.
Avoid break costs with a flexible fixed rate loan
Did you know that some loan types allow you to make unlimited additional repayments with a fixed rate, without penalty?
Please call us on 1300 889 743 or complete our free assessment form to talk to one of our mortgage brokers who can offer you practical advice.Source: www.homeloanexperts.com.au