EXIT FEES: HOW THEY AFFECT YOUR HOME LOAN

Exit fees on a variable rate home loan usually consist of two components: early termination fees and a category we will call ‘Other fees’. Early termination fees, which are not always charged, are also known as deferred establishment fees, deferred admin fees or early repayment fees. These should not be confused with those fees in the ‘others’ category - discharge fees can apply if you pay out a variable rate loan at any time before the contract is up, say, at year 21 of a 25-year loan.

As you can see, it is easy to be tricked by terminology, as each bank uses different names for their schedule of fees.

The dollar amount owed to the bank if you pay out a fixed-interest home loan before the term is up is called a break cost. Break costs may or may not be charged depending on interest rate movements at the time.

Early termination fees are charged by the banks to discourage borrowers from ‘loan hopping’ and to recoup the cost of establishing the mortgage.

Some home loans have zero exit fees but the majority range from the first one to five years of a mortgage.

There are three methods commonly used by banks to calculate early termination fees on variable rate loans:

1. A percentage of the initial amount borrowed.
2. A dollar figure.
3. Pre-determined extra monthly repayments.

As a general rule, the longer the time remaining on your fixed loan, the larger the break cost will be. If the current interest rate is higher than the rate you locked in, it's likely you won’t be charged a break cost. On the other hand, if the current interest rate has fallen below what you are paying, you may be charged the difference multiplied by the outstanding balance multiplied by the years remaining in the fixed term. This can add up to thousands of dollars.

It's complex but essentially based on three factors with a fixed-rate loan:

1. What interest rate you locked into, compared to the current market interest rate.
2. What length of time remains on your fixed-rate term.
3. The loan amount you initially borrowed.

The days of staying in the same house for 25 years are long gone. These days, statistics tell us the average life of a mortgage is only 4 years. There are many reasons for a mortgage to be repaid early, including:

• Trading up to a bigger, better house as the family grows
• Selling to go overseas
• Moving interstate with your job
• Refinancing to a cheaper mortgage
• A change in your financial circumstances, eg. divorce
• Accepting a lucrative real estate offer

Taking no notice of exit fees on your variable rate loan or break costs on your fixed rate loan can result in a nasty surprise when you sell and discover you have to repay thousands more dollars than you anticipated.

Yes you can. The easiest way to avoid early termination fees is by planning well before you sign up for a variable rate home loan. Ask yourself how long you truthfully intend to own the property for. Will you move or refinance in, say, the first 5 years?

If there is the slightest chance that the answer is yes, you need to look seriously at early termination fees associated with home loan products. Sometimes, a variable rate loan with a slightly higher interest rate but no exit fees can work out much cheaper if you repay early. You can avoid break costs on a fixed loan simply by being aware that this cost is likely to be charged if you pay out the loan when current variable rates are lower than what you are paying on the fixed loan.

We have prepared a table that clearly documents each standard variable rate home loan product with the early termination fees that apply. We have used a borrowed amount of $250,000 over 25 years to keep the comparison balanced. After compiling a short list of loans to investigate further, we suggest you ask the banks in question about their policy on the application of these fees.

You can't. There are so many variables involved it is difficult for us to give you an accurate idea of break costs. The daily movement of wholesale interest rates make our calculations unreliable. This is particularly evident with the wild fluctuations we are seeing in the financial markets at the present time.

However, the following hypothetical will give you an idea.

• Fred borrowed $250,000 on a 3-year fixed rate loan 6 months ago. The fixed rate was 9% and, at the time, the money market rate for a 3-year fixed loan was 7.44%.
• Fred now wants to refinance, with two and a half years to go on the loan. The money market rate for a 2.5 year fixed loan has now dropped to 5.55%.
• The total break cost is $10,300, based on the outstanding balance and the current money market rate.

Before rushing to refinance to take advantage of low interest rates, think about the effect break costs could have on the time it takes to profit from a lower interest rate. The time to talk break costs is before you sign up for the loan. Ask your lender to explain the ramifications under a range of different scenarios.