Breaking a fixed-rate home loan: What are break costs?

With the cash rate now at a record low of 0.1%, many people, including those with a fixed-rate home loan, may be wondering if they could be getting a better deal.

If you’re considering breaking a fixed-rate contract, there will likely be “break fees” involved. But what are they and could it still be worthwhile financially to make the switch?

Can I break a fixed-rate home loan contract?

It is possible to break a fixed-rate home loan contract before the end of the determined timeframe, but doing so is likely to incur fees. Breaking a contract could mean refinancing the home loan or paying it off early. The fees often include a break cost and a discharge fee. These could be named differently depending on your lender, so it is a good idea to contact them directly to find out more about what fees may be involved in breaking the contract.

→Related article: How to switch home loans

What’s a break cost?

The “break cost” or “break fee” of a loan is a fee some lenders may charge people who want to end their fixed-rate home loan before the end of the fixed-rate term in the contract. This fee is designed to compensate the financial institution for any loss of profit it faces as a result of a customer breaking the terms of the contract, including administration and its own wholesale borrowing costs. It does not typically apply to other types of loans, such as variable-rate loans.

The break fee amount can vary between customers, as it is calculated according to the conditions of a customer’s loan (see below).

How are fixed loan break costs calculated?

Generally, the break costs you’re asked to pay will be based on three main factors of your fixed-rate home loan:

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

The Australian Securities and Investments Commission (ASIC) advises on its Moneysmart website that as a general rule, “the more interest rates have come down since you took on the fixed rate loan, the higher the break fee will be”.

The calculation of break fees involves the Bank Bill Swap Rate (BBSR), which is the interest rate your financial institution is charged to borrow the money from the wholesale market. This changes daily (if not even more frequently), and can be used by financial institutions to determine the cost of funding your loan. The lender will compare the BBSR from the time you took out the loan with the rate at the time you intend to break the contract. It will then use the BBSR at the time you are breaking the contract to help calculate the amount your loan will cost it over the time remaining in your contract.

It’s a good idea to be aware of the costs associated with breaking your fixed-rate loan term before you decide to switch or pay it off early.

Can I avoid break costs?

That comes down to the type and conditions of the loan you have. Usually, if you are planning on breaking a fixed-rate home loan contract, you will be required to pay break costs. The way to avoid this could be to see out the remainder of the term before switching.

If you are in the market for a home loan, it could be wise to ask your financial institution what break fees are associated with its home loan products, and to take this into consideration when choosing your loan.

It may also pay to compare a different type of loan, which, for example, may have a slightly higher interest rate but lower break fees, to see if that option would work out cheaper if you decide to repay it early.

It’s worth noting that “break fees” are different to “exit” fees, which only apply to some loans that were signed before 1 July, 2011, which is when they were banned by law. The Moneysmart website states that these fees are also called “early termination”, “deferred establishment” or “early discharge” fees.

Is it worth breaking a fixed-rate home loan to get a cheaper rate?

With many fixed rate home loans on Canstar’s database receiving interest rate cuts following the RBA’s cut to the cash rate in November, it is possible there could be a better deal out there than a fixed-rate home loan contract from months or years ago. This would likely mean less interest being paid over the life of the loan. However, before you make the switch, it is a good idea to find out how much you are likely to pay in fees, to determine whether it will save you money over the term of the new loan.

To begin with, you may wish to compare home loans on our database to understand the rates available, including the features you want (perhaps an offset account or redraw facility), and running your own calculations of how much difference there will be in repayments between your current loan and the others you are considering. Then weigh this up with the break fees to determine how long until you would break even, assuming interest rates (if you’re considering switching to a variable rate) and ongoing fees stay the same. You will also want to take into consideration discharge fees, application fees (with the new lender) and whether you will be required to pay stamp duty when refinancing. It is also a good idea to consider the length of the term, as switching to a new loan with a better rate but extending the length of the loan could cost you more over the lifetime of the loan.

You can also contact your current lender to see if you can negotiate a better deal on your home loan. If you switch loans with the same provider, you may have to pay a switching fee.

The comparison tables below display some of the fixed rate home loan products on Canstar’s database with links to lenders’ websites, for refinancing owner-occupiers in NSW making principal and interest repayments on a loan of $350,000 with an 80% LVR. Choose between the 1-year fixed, 3-year fixed and 5-year fixed tabs to view results most relevant to you. The results are sorted by ‘current rate’ (lowest to highest), then by company name (alphabetically). Before committing to a particular home loan product, check upfront with your lender and read the applicable loan documentation to confirm whether the terms of the loan meet your needs and repayment capacity. Use Canstar’s home loan selector to view a wider range of home loan products.

Lowest interest rates for 1-year fixed home loans

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.

Lowest interest rates for 3-year fixed home loans

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.

Lowest interest rates for 5-year fixed home loans

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.

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Cover image source: bbernard (Shutterstock)

This article was reviewed by our Sub Editor Tom Letts before it was updated, as part of our fact-checking process.

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