What are break costs?

According to the Australian Bureau of Statistics (ABS), Australians collectively refinanced around $18 million of home loans in the month leading up to March 2017. For those property owners who refinanced a fixed-rate home loan, this may have incurred a break cost.

What’s a break cost?

When you enter into a fixed-rate home loan for a fixed term (commonly three or five years), the rate of interest that you are charged is calculated based on the lending institution’s prediction of the likely interest rate movements over the course of that term. If the lending institution believes that interest rates will decrease over the length of the lending term, the fixed rate that you pay will be slightly lower than it would otherwise be. If the lending institution believes that interest rates are on the way up, the fixed rate that you pay will be slightly higher than it would otherwise be.

When you break the term of your contract, the break cost is designed to compensate the financial institution for any loss of profit that has been factored in to the term of the contract.

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How are break costs calculated?

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.

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Why do break costs matter?

The days of staying in the same house for 25 years are long gone. Here are some of the common reasons for a home loan to be repaid early:

  • 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 break costs on your fixed rate loan can result in a nasty surprise when you sell.

Can I avoid break costs?

Yes, you can. 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 the break fees associated with home loan products. Sometimes, a variable rate loan with a slightly higher interest rate 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.

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