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.
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.