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Break costs on a fixed mortgage rate

Do you have a fixed mortgage rate or looking to get one? In this article we explore break cost fees and how to calculate break costs.


When you have a fixed mortgage rate, you’ll often get warned of break cost fees. These are fees imposed by your chosen lender if your pay out your home or investment property loan early, switch your product or interest rate, or change your payment type before your contract date.


When you’re shopping for suitable home loan rates, it’s important to account for the possibility of break costs. This is something that your chosen lender or mortgage broker might explain to you when purchasing or refinancing your home loan.


When do you have to pay break cost fees?


With a fixed mortgage rate, you may expect to pay break cost fees for the following reasons:

  • If you sell the property during your fixed term contract

  • You make repayments above the minimum repayments

  • When you refinance your home loan or switch your home loan to another loan type

  • If you pay off the loan before the fixed term

  • If the total amount owing is due, immediately

Why do banks charge a break cost fee with a fixed mortgage rate?


When you enter an agreement with a bank to finance a house or investment property loan, you’re essentially locking in an interest rate for a specified period. To fund your loan, banks will also receive funding from a third party, generally the money market. The money market funds banks with wholesale interest rates for the period you agree to lock with your chosen lender.

When breaking a fixed mortgage rate contract banks may charge you a fee to recoup losses from the money market
When breaking a fixed mortgage rate contract banks may charge you a fee to recoup losses from the money market

Banks will need to cover the cost of the funding that they receive from the money market. Thus, when breaking a fixed contract, they’ll charge you that fee to recoup any losses they make with their third-party contract.


How banks calculate break costs


Lenders have different formulas to do this. Generally, they’ll often use the following formula to calculate break costs:


Break cost = Loan balance owing X Interest rate differential X Time owing on contract


Lenders then convert the final cost into the dollar value respective of the current market. When calculating break costs and charging that fee, banks don’t generally make a profit from doing so. It’s purely to ensure that their losses, from you breaking that contract, are accounted for.


How to avoid break costs?


Break cost fees are applicable to fixed mortgage rate products. To avoid the possibility of ever having to pay these fees you may choose to select variable or split home loan rates. These home loan rates allow homeowners to make extra repayments without penalty. Additionally, they allow you to refinance your home loan whenever you like.


Other strategies that can help you to avoid these fees:

  • Fix home loan rates for shorter periods

  • Only pay maximum loan repayments

  • Avoid selling your home during your fixed contract

  • Avoid having to refinance your home loan during your fixed contract

These recommendations are broad, and it’s advised that you speak to a finance or mortgage professional before making financial decisions.


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