A Short Guide to Understand Fixed Rate Break Costs

If you are breaking a fixed rate home loan, you can expect some additional costs in the form of ‘break costs’. However, break costs vary from lender to lender and are usually not so easy to figure out. If you are someone with an existing fixed rate loan, here is everything you need to learn about break costs, what they are and how they can be calculated.

The Break Costs

Break costs is there to assist the lender when a borrower discontinues their fixed rate home loan and to provide sufficient coverage to the lender to cope up from any possible loss. Break costs is an estimate of the loss a lender might suffer in the event of a loan break. Moreover, in case of refinancing, break costs may only be applicable if the variable rate is lower than the fixed rate product.

Breaking a Fixed Loan – What does it mean.

There are scenarios and situations that dictates breaking a fixed loan, such as -

• If making additional home loan repayments beyond the agreed amounts

• If the loan is in default or if the repayment is not done

• In case the loan is refinanced to a new product or from a new lender

• When the loan is repaid in full much before the end of the loan term

Calculating Break Costs

One thing you must be well aware of is that calculating the break costs in not an easy thing to do, as there are numerous things to be considered. Thus, it’s best to ask the lender directly what to expect in case of a break.

Let’s try to understand the break costs through an example intended for explanation purposes onlyhere -

Kevinbuys a home with a $500,000 loan with a fixed rate of 4.5% for 5 years and he makes interest only repayments. After 3 years, he decides to sell the property and repay the outstanding loan amount in full.

The variable rate at the time of sale is 3%, a difference of 1.5% from the fixed rate.

Thus, to calculate break costs –

Break cost = (loan amount outstanding) x (wholesale rate change) x (term remaining on loan)

Break cost = ($500,000) x (1.5%) x (2)

Break Cost = $15,000

Remember that different lenders will calculate break costs in a different way. So if you have any doubts or queries about break costs, it’s better to speak with the bank directly. If you need any assistance in fixed rate or variable rate home loans Australia, talk to the experts at Loans Direct.