An adjustable-rate home loan might seem reasonable considering rising borrowing costs. It is possible that you have an existing fixed rate home loan and want to lock in a lower fixed rate.

There are many hidden pitfalls to fixed-rate home loans, according to mortgage brokers throughout the country. Break fees are costly and should be avoided. So before you consider breaking out of an existing fixed-rate home loan, you’ll need to consider these fees – which, in addition to being expensive, can be hard to work out.

Peter Cooper, managing director of Cooper Financial Connections in Brisbane-based, says that borrowers need to thoroughly examine how banks calculate break cost before applying for a loan. Cooper noted that banks should be more transparent.

“When explained to the borrower, most understand the need for a break fee. However, they are generally surprised at the size of the compensation sought by the bank,” Cooper told the Australian Financial Review.

“Over the years, there has been greater emphasis on disclosure of fees and charges so a borrower can make an informed decision when comparing loan products, but this trend to greater transparency does not appear to apply to banks disclosing break funding calculations.”

Calculation of break fees

There are four main components that go into calculating a break fee: the remaining term of the loan, the balance outstanding, the bank’s funding cost when the loan was written, and the bank’s funding cost when the loan was discharged.

“If we estimate that we’ve made a loss as a result of the fixed rate being repaid earlier than expected, we calculate an early repayment adjustment (ERA) as our reasonable estimate of our loss in accordance with our usual formula,” said a spokesperson from CBA. 

“This formula takes into account the difference between our wholesale market swap rate for the fixed-interest period on the date the interest rate was fixed and the wholesale market swap rate as at the date of the early repayment for the balance of the fixed-interest period.”

Strategies to minimize break fees

Peter Bond, who is director and principal advisor at Trinity Wealth Services (Director/Principal Advisor), said that paying a fee was inevitable. There are many options.

  • Find out what the interest rates are like since you took out your mortgage. If the bank bills swap rate, BBSW at the time you took out the loan was higher than when you intend to repay it, then you can expect an exit charge.
  • Most banks will offer a quote on the penalty to cancel your loan before you do. This gives you a chance to decide whether you’re comfortable with paying that much in fees before deciding to terminate the loan.
  • If there’s a strong chance that your financial situation or priorities will change over the coming years, then avoid locking in your loan. You should choose a product that is in line with your financial goals, just as with all financial decisions.
  • Some borrowers split their loan in fixed and variable portions. The fixed portion should be determined based on your financial situation.
  • Low interest rates make it possible to get out of a loan even though people are less likely to sell their houses or leave loans.

    Because if fixed rate funding rates rise, then a mortgage discharge will allow the bank to replace the loan with a higher interest at a profit. If that was the case, the client would be able exit the loan at a profit.