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Looking at closing a fixed loan or paying extra?
Let's run through the process & potential costs involved with leaving or overpaying a fixed term home loan before it converts to variable.
“You cannot make progress without making decisions.”
How do break costs work?
Some lenders charge an early repayment fee or break cost if a loan is fully paid before the end of your loan term. These fees vary between lenders and loans and are disclosed in your loan contracts issued by your lender. Fixed rates loans will generally charge a repayment cost which is referred to as an economic cost or a fixed rate break cost when you pay back your loan earlier than expected. Most lenders will allow you to pay off a small additional amount off your mortgage each year without being charged.
Lenders borrow money using the Bank Bill Swap Rate and their rate is locked in at the same time the fixed rate on a home loan is locked in. When you repay your home loan earlier and interest rates have fallen the lender may not have the ability to re-lend the money at the higher interest rate and will incur an economic cost. The economic cost is passed on to you as a break cost.
For example: you take out a home loan for $500,000 at a fixed rate of 4.00% over 3 years and decide to refinance or pay the loan off in 1 year or refinance your loan. During that year interest rates fall however the lender’s cost of funds would remain the same as the time the loan was made. The lender will therefore need to carry on the loan at the original cost. Economic costs can be costly so if you are hoping to pay your loan off early a fixed rate loan mightn't be a great idea.
There may be situations where a break cost may be less that the financial benefits you may receive from refinancing to a cheaper interest rate. It is best to compare the costs across the life of the loan to help you decide if refinancing or repaying your fixed rate home loan earlier is of benefit to your situation.
Speak to your mortgage broker today about your early repayment & break requirements.
Kind Regards, The Newstead Group Team