If you have a fixed rate home loan and you are still in the fixed period, you may incur additional charges if you refinance or sell your property and exit from your loan. These charges for breaking the fixed rate home loan contract are called break costs. 

Why do mortgage lenders charge break costs?

Because the break costs of leaving a fixed rate home loan early can prove quite expensive, it’s often worth considering whether it would be more affordable to wait for the fixed interest period to expire before looking into refinancing the loan. 

Lenders charge break costs because when a borrower breaks a fixed term contract, the lender is going to lose the money it was expecting to receive as income from the loan’s interest. 

This can leave a gap in the bank’s previously prepared budget, especially if the bank’s wholesale funding costs have fallen over the time since you first took out the fixed rate loan. This is often (but not always) reflected by the lender cutting its home loan interest rates.

As a result, the lender will calculate how much they will lose by you ending the loan contract ahead of schedule and charge you accordingly.

How much are home loan break costs?

Different lenders calculate break costs using different methods, but you may be able to estimate your break costs using the following formula: 

Remaining loan amount x remaining fixed term x change in costs of funding = Break cost

This means that the higher your remaining loan amount, the longer your remaining fixed term, and the greater the change in funding costs, the more you may have to pay in break costs if you exit your fixed loan early. 

For example: Imagine you had a home loan with an interest rate fixed for five years, but wanted to sell you property or refinance with another lender after just three years had passed. Assuming you had $500,000 still owing on the mortgage, and the bank’s cost of funding had fallen by 1 per cent over the past three years, your break costs could work out as follows: 

$500,000 x 2 years x 1% = approximately $10,000

(Hypothetical calculation is for informational puposes only)

Keep in mind that banks and mortgage lenders don’t usually make their funding costs public, and other factors may also be in play, so it may not be easy to estimate your break costs if you choose to exit your fixed term early. You may want to contact your lender to request a break costs quote before making a decision to exit your fixed rate home loan. 

Are break costs the same as exit fees?

While break costs and exit fees sound similar, there are important differences between the two.  

Before 2011, if you had wanted to cancel your home loan contract (not just fixed rates home loans – variable rate home loans too) before the loan term expired, you would have usually been charged exit fees. These fees were set by lenders, and their costs could be high, making them a major deterrent for consumers who were comparing home loan rates and wanting to switch home loans.

The Federal Government stepped in and legislated that from 1 July 2011, lenders were no longer able to charge customers who wished to repay their home loan early.

Despite these changes, if you refinance your home loan you may still be charged a discharge fee from your existing lender, plus application fees or upfront costs by your new lender. However, these fees are legally required to only cover the lender’s admin costs, and usually come to a couple of hundred dollars. 

Keep in mind that there may also be other costs to consider when refinancing, such as stamp duty. 

What do break costs mean for your refinance?

The more it costs to switch from one home loan to another, the less affordable your refinanced mortgage could ultimately turn out to be. Even if you switch to a mortgage offering a lower interest rate that saves you money on your home loan, it may take a long time for these savings to make up for these high switching costs and ultimately “break even” on your home loan. 

You may want to compare home loans before you refinance and consider whether the value of lower interest rates and other features and benefits may help offset any break costs you may be charged. A mortgage broker may be able to help you work out the best solutions to suit your budget and your financial needs.