What are break costs?
Break costs are fees charged for exiting a fixed rate home loan before the end of the term. They compensate the lender for the interest it would have received had you seen out the term.
You’re likely to face break costs if you refinance your mortgage, pay off the debt, or sell your property during a fixed rate period.
Break costs are sometimes referred to as ‘early repayment’ or ‘early termination’ fees, but are separate from ‘discharge fees’, which cover the administrative process of discharging a mortgage.
When do break costs apply?
Break costs may apply if:
- You pay off your loan before the end of a fixed rate period
- You make extra repayments that exceed the ‘prepayment threshold’, which is the maximum amount your lender allows
- You refinance before the end of a fixed rate term
Even if you’re just topping up the loan, break costs can apply as you’re restructuring the contract - You default on your loan
Limits on how much extra you can pay off your mortgage during a fixed rate period vary between lenders, but a maximum of $10,000 extra per year is common.
Why is it so expensive to exit a fixed loan?
Break costs only apply on fixed rate home loans, so you likely won’t face them if you have a variable interest rate.
When a lender funds a fixed loan, it usually borrows the money from the wholesale money market and enters an agreement with another financial institution to essentially lock in the rate it’s charged on the money. This helps to protect its profit margin, regardless of what happens to interest rates in the meantime.
If you pay your loan off early, the lender still has to pay the same fixed rate. If variable rates have gone down and that means it’s making a loss from the swap, it transfers that loss back to you.
On variable rate loans, the interest rate goes up and down with the cost of funding, so there’s no need for break costs.
How much are break costs on fixed rate home loans?
Break costs vary depending on:
- How rates in the wholesale market have changed since you first borrowed,
- how much of the fixed term is left, and
- how much you still owe.
You could get lucky—if wholesale rates have risen since you borrowed, your break costs may be minimal or even non-existent. However, in many cases break costs can be a major expense.
How are break fees calculated?
Lenders use a complicated formula based on the above variables to determine your break costs.
Some provide the following simplification so you can get a rough idea:
Break costs = (Wholesale rates when you took the loan - current wholesale rate) * outstanding balance * years remaining on fixed term
This is just an estimate though, and some lenders deliberately don’t publish this formula because it can ‘mislead’ borrowers.
To figure out exactly how much your break cost will be, you’ll probably need to get in touch with your lender.
Are break fees worth it?
If you’re considering breaking a fixed rate home loan and refinancing, you should make sure the potential savings more than offset the break fee.
Even if you’re switching to a mortgage with a lower rate, you still might be better off seeing out the fixed term to avoid significant break charges.
You can use our home loan repayment calculator to work out how much you might save by refinancing, while your lender should be able to give you an estimate of your break costs to help you crunch the numbers.
Will I always have to pay break costs?
If you’re exiting a fixed loan before the end of the term and wholesale rates have dropped, you’ll almost always have to pay break costs.
If wholesale rates are up and your break cost calculation comes out negative, you might not have to pay anything (but there’s little chance your lender will pay you the difference).
Another possibility is if you’re selling your property and your lender allows it, rather than breaking the fixed-term, you might be able to transfer your loan onto your new property. Lenders call this ‘home loan portability’.
