What does it mean to ‘break’ a fixed loan and why might I do this?
Breaking’ your fixed loan means you’re requesting that your bank / lender cancel the fixed interest rate contract you have on your home loan.
For example, you may have fixed the interest rate on your $500,000 home loan for 2 years at 4.95%. But rates have decreased, and are now 2% for the same term. If you want to take advantage of the lower rate, you need to request that the bank breaks your fixed loan to allow you to re-fix it at the lower interest rate.
Other reasons to break your fixed home loan include refinancing with another bank, or taking advantage of the flexibility to make a lump sum repayment you hadn’t anticipated when you set up the initial loan. For all these scenarios, your bank or lender may change you a fee, known as a break cost or early repayment fee, to break the fixed loan.
What is break cost?
Breaking a fixed rate may incur an Early Repayment Recovery (ERR) also known as a break or prepayment fee. This is the actual cost to the bank / lender passed on as an additional cost when you have fixed a loan in for a period of time and want to break it early.
It will be calculated based on the cost to the bank of borrowing the money on the day you signed the contract, compared with the cost of borrowing money today. In New Zealand, banks are not allowed to profit from cancelling your loan contract, so this is a true cost to the bank.
The bank, however, is allowed to charge an administration fee, and this can range from $50 to $200. For clarity, your quote will separate out the administration fee and break cost.
How are break costs calculated?
Each bank or lender has their own way of calculating your break costs. Essentially however, this is based on the loan amount, the difference between the interest rate you’re fixed in for and the current interest rate, and the remaining term on the fixed rate.
As an example, let’s say you wish to break a fixed rate home loan with a balance of $500,000 and two years left on the interest term.
The bank’s cost when you fixed was 4.00% p.a., but the bank’s current borrowing cost has fallen and is now 3.00%, so the interest rate difference the bank will use is 1.00% p.a.
The approximate break cost to the bank would therefore be $500,000 x 1.00%p.a. x 2 years = approx. $10,000. The reason an approximate value is given is because there may be accrued interest or other additional bank fees on top of this.
Why not have a go at working out your break costs on our Break Cost Calculator? The link is below.
Are there any other costs or fees associated with breaking a home loan?
Your bank/lender may charge you administrative fees to make this change to your home loan.
If you’re refinancing, the bank will charge you a discharge fee to de-register the mortgage over your property. This fee is also normally charged when you’ve fully repaid your home loan and you request the bank to release the mortgage over your property.
Our Tella home loan specialists are here to help you navigate your way through breaking your fixed rate home loan. Send us a message in the chat box at the bottom right-hand side of the Tella website.