- Break fees are charged by lenders when a borrower pulls out of a fixed-rate home loan contract before its end date
- Lenders have their own break fee calculations, taking into account how much money they stand to lose through borrowers ending their fixed-rate contracts early
- Break fees can cost in the thousands of dollars, particularly in a falling interest rate environment
Many borrowers may consider whether to take out a home loan at a variable or a fixed interest rate. The choice will depend on many factors, including your own circumstances and the outlook for interest rate movements (which can be very difficult to forecast).
See also: How to choose between a fixed-rate or variable-rate home loan
But before you opt for a fixed interest rate, it’s important you’re aware of break fees.
What are break fees?
Break fees, or break costs, are charged by your lender if you leave your fixed-rate home loan before the end of the fixed term.
This can happen when you:
- sell the home
- refinance
- switch to a better interest rate (even if it’s with the same lender)
- pay off more of your home loan than your fixed repayment schedule allows
Break fees are set by individual lenders and take into account wholesale finance rates at the time you took out your fixed-rate loan and at the time you want to break it.
They'll also depend on how far into the fixed-term contract you are when you decide to end your loan.
Each lender will have its own method of working out how much you’ll be up for in break fees - and you may be shocked at the cost.
How do you calculate break fees?
Lenders don’t always disclose how their break fees are calculated and each lender can calculate them differently. But in most cases, the borrower will usually have to repay the shortfall of what the lender would have received had the fixed-rate contract gone to its full term
A simple formula is generally expressed as:
Loan amount prepaid x (Interest Rate Differential) x Remaining Term = Break Cost
Some terminology
The ‘differential’ is the bank’s wholesale funding rate at the time you took out your loan, minus the bank’s wholesale funding rate at the date you broke your contract.
The wholesale funding rate is what the lender pays in interest on the funds it borrowed to lend you. It can also be referred to as the Bank Bill Swap Rate, or BBSW.
Variations in calculations
Some lenders might also set their own wholesale funding rates. These rates can vary daily so the final break fee can also change daily as well.
Most lenders ask that you contact them so they can give you an accurate calculation of the break cost you’ll face. (As covered, this may vary slightly according to the exact day your loan contract ends.)
Just for fun, let’s look at the formula Westpac uses to calculate its break costs:
∑[i*Badj +Badj -Badj] * dƒt -CB-∑[i*Bnew +Bnew -Bnew] * dƒ t-1 t-1 t t-1 t-1 t -(CB-P)
You get the picture. It can be complicated.
Fixed-rate loan break fees: Case Study
But let's check a simplified example. Delia Breaker has a fixed-rate home loan but is selling up her property and paying out her loan.
She’s exiting the loan two years into a three-year fixed term, after having borrowed $400,000 over 25 years.
Here's a rough calculation:
At the time of terminating the loan, the three-year BBSW is 2% while two years previously it was 3.5% - a differential of +1.5% (or 0.015).
After two years, there is $368,000 remaining on the principal of Delia’s loan.
The simple version of the formula would be $368,000 x 0.015 x 1 = $5,520.
In this case, Delia would have to pay more than $5,500 on top of the payout figure on her home loan.
If she’d stuck it out for just one more year, she could have avoided the penalty.
[The above calculations are for illustration purposes only. There may be other administration fees for breaking a fixed-term loan early. As always, contact your lender if you have queries.]
What if the interest rate goes up?
You may have noticed the above calculation assumes interest rates headed lower during the fixed-rate period.
If you’d locked in at a low rate and market interest rates had gone up by the time you wanted to terminate your loan, you might not have to pay any break fees (although you can expect to be hit with other fees, such as exit or discharge fees).
This is because the lender will be only too happy to relend the money it had allocated to you to someone else at a higher rate. In this case, the lender stands to make a profit from you paying out your loan early.
Savings.com.au’s two cents
Fixing your home loan rate can be a tempting prospect, particularly when fixed rates are considerably lower than the variable rates on the market. But financial markets are highly unpredictable, even to so-called experts.
As with most contracts, there are penalties for breaking a fixed-rate home loan. It’s not uncommon for those with larger loans to be hit with paying tens of thousands of dollars in break fees if they're looking to get out of a higher fixed rate to switch to a lower rate on the market.
If you’ve opted for a fixed-rate loan, it’s probably for good reason - whether that be a competitive rate at the time or for cash flow certainty. If you’re looking to refinance the loan to a lower interest rate elsewhere on the market, ensure you account for the break costs you’ll likely face. It may make the exercise costly and not worth your while.
Generally, it’s recommended you serve out your fixed-rate term and prepare for the time when you can look around for a better rate - or a more flexible loan to suit any change in your circumstances.
How to avoid break costs?
The foolproof way to avoid break costs is to serve out your fixed-rate term. However, if you need to sell or refinance during this time, you will just have to cop the penalty.
There are a few other ways you may be able to avoid - or minimise - break costs:
- Port your existing loan: If you are selling your home to purchase another, you can ask your existing lender whether you can transfer your existing loan to the new property. There will likely be some fees involved in this process but you may be able to avoid costly break fees.
- Wait for interest rates to rise: If you're looking to break a fixed-rate contract, you generally pay much higher break fees when interest rates fall during the fixed rate period. If you can wait for them to rise, it may minimise the break fees you face.
- Try to reduce the loan balance first: Most lenders cap the amount borrowers can make in extra payments on fixed-rate loans, generally between $10,000 - $30,000. Try to contribute the maximum amount permitted before you break the loan contract. This will effectively reduce the principal the penalty will be calculated on.
- Try negotiating with your lender: If you're planning to refinance your loan, it's worth speaking with your existing lender to see what it may be able to offer if you refinance to a lower rate with them. You may have some extra bargaining power if you have an unblemished repayment history and good equity in the property.
What about refinancing cashback deals?
From time to time, some lenders may also offer refinancing rebates which effectively lower the cost of their break fees if you refinance with the same lender.
Cashback offers from external lenders can also cover some, or all, of the cost of breaking your fixed-rate loan if you sign a new loan contract with them.
See also: Current home loan cashback offers and deals
Be aware though, while getting a cash payment upfront to cover your break costs and set-up expenses can be tempting, it's important to consider the loan product as a whole to determine whether it best suits all your needs.
Competitive refinancing interest rates
If you're considering refinancing your loan, the table below may be useful in helping you find a competitive home loan rate:
Lender Home Loan Interest Rate Comparison Rate* Monthly Repayment Repayment type Rate Type Offset Redraw Ongoing Fees Upfront Fees Max LVR Lump Sum Repayment Extra Repayments Split Loan Option Tags Features Link Compare Promoted Product Disclosure
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