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 loan before the end of the fixed-rate term in the contract. This fee is in addition to other costs that can be charged when paying out a loan, and does not typically apply to other types of loans, such as variable-rate loans.
If you break the term of your contract, the break fee is designed to compensate the financial institution for any loss of profit it suffers as a result.
The break fee amount typically varies between customers, as it is calculated according to the conditions of a customer’s loan (see below). When you enter into a home loan with a fixed-rate term (commonly three or five years), the rate of interest that you are charged is typically calculated based on the lending institution’s prediction of the likely interest rate movements over the course of that term. If the lender believes that interest rates will decrease over the length of the lending term, the fixed rate that you pay may 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 likely be slightly higher than it would otherwise be.
How are break costs calculated?
It can be complex, but generally the break costs you’re asked to pay will be based on three main factors of a fixed-rate loan:
- What interest rate you locked into, compared to the current market interest rate.
- What length of time remains on your fixed-rate term.
- 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”.
Why do break costs matter?
There are many reasons why people have to break the term of their fixed-rate loans, including:
- Trading up to a bigger, better house as your family grows
- Selling to go overseas
- Moving interstate with your job
- Refinancing to a cheaper mortgage
- A change in your financial circumstances, e.g. divorce
- Accepting a lucrative offer from someone hoping to buy your house.
It’s a good idea to be aware of the costs associated with breaking your fixed-rate loan terms, to avoid a nasty – and potentially expensive – surprise when it comes time to settle the loan.
Can I avoid break costs?
That comes down to the type and conditions of the loan you decide to take out in the first place.
It could be a good idea to ask yourself how long you intend to own the property for – will you move or refinance before the end of the fixed rate term you’re considering? If there is a chance that the answer is yes, it could be wise to ask your bank what break fees are associated with their home loan products, and to take this into serious 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 an “exit” fee, 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”, “deferred application” or “early discharge” fees.
“Credit providers are not permitted to use exit fees to discourage you from switching your loan or to punish you for doing so,” the website states.
If you’re currently considering a home loan, the comparison table below displays some of the variable rate home loans on our database with links to lenders’ websites that are available for first home buyers. This table is sorted by Star Rating (highest to lowest), followed by comparison rate (lowest-highest). Products shown are principal and interest home loans available for a loan amount of $350K in NSW with an LVR of 80% of the property value and that offer an offset account. 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.
*Comparison rate based on loan amount of $150,000 and a term of 25 years. Read the Comparison Rate Warning
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