Whether you’re taking out a home loan for the first time, considering changing your loan terms or thinking about switching lenders, you’re going to come across the term ‘break fee’.

In fact, these two little words can play a crucial role in your financial planning and decision-making, so it’s important to understand what a break fee means and how it can affect you.

What exactly is a break fee?

A break fee is a charge applied by your lender when you decide to terminate or significantly alter a fixed-rate loan before the end of the fixed term. A break fee can also be known as an ‘early repayment fee’ or ‘economic cost’.

When do break fees apply?

 Break fees are usually associated with fixed-rate home loans. This type of home loan gives you the stability of a constant interest rate over a set period of time (usually from one to five years).

If you’re on a fixed-rate home loan and decide to refinance, switch to another lender, make significant extra repayments, or sell your property during this fixed period, a break fee may apply.

Why are break fees charged?

When lenders agree to a fixed-rate loan, they expect to get a certain return based on the interest rate agreed upon. Now let’s say the market interest rates drop and you decide to take advantage of these lower rates by refinancing – your lender could potentially lose out on the interest they were expecting. 

The break fee helps to offset this loss and compensate the lender.

Calculating the break fee

The calculation of break fees can be a little complicated and will also vary from lender to lender.Generally speaking, the break fee amount will depend on factors such as:

• The time left on your fixed-rate loan term: The longer the time remaining, the higher the potential break fee. ‍
• The amount you’re breaking: A larger loan amount will typically mean a higher break fee.‍
• Market interest rates: The difference between the fixed interest rate of your loan and the current market rate for similar loans will influence the break fee.

Pros and cons of fixed-rate loans with break fees

Pros:

• A stable interest rate: Fixed-rate loans offer protection against rate rises, so you can benefit from consistent repayment amounts.
• ‍Easy budgeting: Knowing your exact repayment amount every week, fortnight or month makes budgeting simpler.

Cons:

• Lack of flexibility: Fixed-rate loans can be less flexible in terms of making extra repayments or refinancing.‍
• Potential break fees: As we’ve been discussing, if your circumstances change and you need to break the loan, you may need to pay a hefty break fee.

What to consider before breaking a fixed-rate loan 

• Cost-benefit analysis: Compare the potential savings you’ll get from refinancing at a lower interest rate against what you’ll pay in break fees and other charges.‍
• Future interest rate changes: While it’s not easy to predict interest rate changes, it’s important to consider what could happen in the market over the course of your fixed term.
• ‍Personal circumstances: Changes in your personal or financial situation– such as losing your job or having a baby – might mean you need to reconsider your loan structure.

Tips for fixed-term home loans

Thinking about taking out a fixed-term home loan?Here are some tips to help you avoid the sting of break fees: 

1. Always read the fine print: Before signing up for a fixed-rate loan, understand the terms regarding break fees.
2. Talk to a professional: Chat with a financial advisor or mortgage broker to understand the implications of break fees in your specific situation.
3. Plan for the future: Consider your long-term plans and the likelihood of needing to break your fixed-rate loan early.

While fixed-rate home loans can offer some much-needed stability and security, it’s crucial to understand the implications of break fees should you need to change or terminate your fixed term early. 

By doing your research and equipping yourself with all the information you need about break fees, you can make the best financial decision for your specific situation - and enjoy the benefits of a home loan that’s right for you.

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This article is intended to provide general information only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Please consider seeking financial advice before making any decision based on this information.