In Octobers review, the Reserve Bank dropped the Official Cash Rate by 50 basis points from 5.25% to 4.75%.
As a result, banks have been lowering their interest rates.
With interest rates falling, borrowers are now wondering if they should “break” their fixed term mortgages to “re-fix” on the new, lower interest rates.
In a falling interest rate environment, the downside to “breaking” a fixed term mortgage is that banks will charge a Fixed Rate Break Cost, which often cancels out the benefit of going onto a lower interest rate.
What are Fixed Rate Break Costs?
A Fixed Rate Break Cost is the penalty that borrowers get hit with if they opt to break a fixed term mortgage before it matures – to either repay all or some of their mortgage or to change their interest rate.
Depending on the size of the mortgage, this Fixed Rate Break Cost can cost tens of thousands of dollars.
This Fixed Rate Break Cost can vary depending on the current interest rates and how long the fixed term has left to run. This cost is to compensate the bank for a reasonable estimate of their loss resulting from changing your interest rate or repaying your fixed term mortgage.
Why do banks charge Fixed Rate Break Costs?
When you break your fixed term mortgage with the bank, the bank is forced to break the funding arrangements it has in place with wholesale funders. The bank gets penalised for breaking its loan early, so the bank passes that cost on in full to the end borrower – with no discounts or waivers.
How are Fixed Rate Break Costs calculated?
It’s a complicated process, but the calculation looks something like this –
[Percentage fall in wholesale interest rates since you fixed the loan] x [Your loan balance] x [Years until the fixed rate matures]
For example –
A borrower opts to fix for 5 years at 5.95% and the wholesale funding rate, what the bank borrowed the money at, was 4.00%.
A year later, with four years left on their term and $600,000 left on their mortgage, the borrower wants to break the loan. At that point the wholesale funding rate has dropped to 2.75%.
So, the Fixed Rate Break Cost would be calculated as follows:
4.00% – 2.75% = 1.25%
1.25% x $600,000 = $7,500
$7,500 x 4 years = $30,000
Total Fixed Rate Break Cost = $30,000
Want to find out more?
If you’re considering breaking your fixed term mortgage or you’re looking to refix, we recommend you seek expert help from one of our experienced Mortgage Advisers.
