Refinancing Mistakes and Official Sources
Fixed rate break costs: how they are calculated and when breaking is worth it
Why Australian lenders charge break costs on fixed rate home loans, a simplified worked calculation, what triggers them, how to reduce them and how to decide whether to break.
A break cost is what your lender charges if you end a fixed rate early: by refinancing, selling, switching to variable or repaying more than the allowed extra amount. It compensates the lender for the loss it makes when wholesale interest rates have fallen since you fixed, because it locked in funding at the old, higher rate. If wholesale rates have risen instead, the break cost is often small or nil, although an administrative fee may still apply. The amount changes daily with markets, so always ask for a written quote on the day you plan to break.
This guide is part of home loan refinancing mistakes. Figures are illustrative; each lender uses the formula in its contract.
What triggers a break cost
| Action | Break cost possible? |
|---|---|
| Refinancing to another lender during the fixed term | Yes |
| Selling the property and repaying the loan | Yes, unless the loan can be moved to the new property |
| Switching the fixed part to variable | Yes |
| Extra repayments above the annual allowance | Yes, on the excess |
| Refixing at a new rate before the term ends | Yes, sometimes reduced if staying with the lender |
| Waiting until the fixed term ends | No |
How the calculation works, simplified
Each lender's formula is set out in the loan contract, but the logic is similar:
- Take the rate the lender's funding cost was based on when you fixed.
- Compare it with the current wholesale rate for the remaining fixed period.
- Multiply the difference by the amount being broken and the time remaining.
- Discount the result to today's value, and add any administration fee.
Illustrative example:
- Fixed balance: $400,000 at 6.20%
- Time remaining: 2 years
- Wholesale rate for the remaining 2 years has fallen by 1.00 percentage point since fixing
Rough break cost: $400,000 x 1.00% x 2 years = about $8,000. The real figure would usually be somewhat lower, because the balance falls as you repay and the future loss is discounted, but this gives the order of magnitude. If wholesale rates had fallen by only 0.25 points, the rough cost would be about $2,000. If they had risen, it could be nil.
Is breaking worth it? The decision test
Compare the break cost with the interest you would save over the remaining fixed term only, because after the term ends you could switch for free anyway.
Continuing the example, a variable rate of 5.60% is available elsewhere:
- Rate saving: 6.20% - 5.60% = 0.60 points
- Rough saving over 2 years: $400,000 x 0.60% x 2 = $4,800
- Add switching costs of about $1,500
- Compare: $8,000 + $1,500 = $9,500 cost against $4,800 saving
On these numbers, breaking loses about $4,700. Wait for the fixed term to end, and use the time to plan a switch. If there were only six months left, the break cost would also be much smaller; recalculate with the lender's written quote.
Breaking can make sense when:
- you must sell or move and cannot take the loan with you
- you need to restructure the loan in hardship
- the break cost is small because wholesale rates have not fallen much
Partial breaks: paying too much extra
Break costs are not only about refinancing. Suppose your fixed loan allows up to $10,000 of extra repayments a year (the cap varies by lender) and you pay in a $25,000 bonus. The $15,000 above the cap may be treated as a partial break. With the same rough method, 1.00 point lower wholesale rates and 2 years left, the cost on the excess is about $15,000 x 1.00% x 2 = $300, plus any administration fee.
The better move is usually to pay $10,000 into the fixed loan and hold the other $15,000 in savings or an offset on a variable split until the fixed term ends, then repay it with no break cost.
Ways to reduce or avoid break costs
- Portability. Some lenders let you move a loan to a new property when you sell and buy, which may avoid a break.
- Use the extra repayment allowance. Pay up to the cap each year; put anything above it in savings or an offset.
- Split the loan. Keep part variable for lump sums and future flexibility; see fixed vs variable vs split.
- Time a sale. If possible, settle a sale near the end of the fixed term.
- Ask for the formula before fixing. Knowing the method helps you plan.
Getting the quote and challenging it
- Ask the lender for a written break cost quote with the date it applies and the method used.
- Ask whether the quote changes daily and how long it is valid.
- Check the loan contract's break cost clause and the amount being broken.
- If the amount looks wrong or was not disclosed properly, complain to the lender. If unresolved, AFCA can consider break cost disputes; see mortgage hardship and AFCA complaints.
Frequently asked questions
Are break costs the same as exit fees?
No. Exit fees on variable home loans taken out from 1 July 2011 are banned. Break costs on fixed loans are allowed because they reflect the lender's economic loss, and they must be set out in the contract.
Can a lender pay me if rates have risen?
Generally no. Contracts usually only charge you when the lender loses, not credit you when it gains.
Do break costs apply in hardship?
They can. If you are in financial hardship, tell the lender, as it may consider options that avoid breaking the fixed rate.
Does refinancing within the same lender avoid break costs?
Not necessarily. Moving from fixed to variable with the same lender usually triggers the same calculation.
Sources
- ASIC Moneysmart — fixed rate loans and break costs
- Australian Financial Complaints Authority — break cost disputes
- Reserve Bank of Australia — interest rate data and market conditions
