Can you break a fixed rate home loan early?

A fixed rate home loan can be a great way to safeguard your finances against any interest rate hikes, allowing you to confidently organise your budget around your monthly repayments. 

But your circumstances can change and over time you might find being locked in to a fixed rate no longer suits you. Some of the reasons why you might want to break your fixed rate contract include:

• Your home loan isn’t working for you and you want to refinance
  

• You want to split your loan
  

• You want to sell your property
  

• You want to increase your loan amount, i.e. top up your loan
  

• You want to pay off part of your loan early
  

• You are able to pay off your loan in full early
  

While your bank won’t prevent you from doing these things, you might find the process isn’t exactly straightforward. Below, we take a look at what you can expect when breaking a fixed rate before your term is up.

When you take out a home loan, your bank funds it with money borrowed from the wholesale money market. This is the network which facilitates large-volume trades between financial institutions and governments.

If you decide to fix your loan, your bank will also fix its funding costs to hedge against any interest rate increases. Exiting your fixed term prematurely comes as a major disruption to your bank, as it still has to pay back the money it owes in the wholesale market.

If interest rates have changed since your loan was funded and your bank incurs a loss, it will recoup this by charging you a fee. This is typically known as a break fee or break cost, but some lenders might also use terms like early repayment penalty.

This can be in the tens of thousands of dollars, so make sure you discuss your options with your lender prior to breaking the fixed rate agreement.

If your lender incurs a loss as a result of you ditching your fixed rate contract, it will pass the costs on to you in the form of a hefty fee. But the size of the fee will vary from customer to customer.

Some of the things your bank will take into account include your outstanding loan balance as well as the amount of time remaining on your fixed rate term. 

It will also consider the difference in swap rates — that is, where rates sat in the wholesale market on the day your loan was funded and where they are sitting when the fixed rate agreement is terminated.

All the above factors can be condensed into the following formula:

Outstanding loan balance x time left on fixed term x difference in swap rates = break fee

Just keep in mind that swap rates fluctuate daily, so if you request a break fee quote from your bank one day it could look quite different the next.

Sarah borrows $500,000 to buy an apartment, and to help her budget she decides to fix her loan for five years. To fund her loan her bank borrows from the wholesale market at a rate of 5% p.a.

Three years later, Sarah decides to sell her property. She has paid off $75,000 on her loan, leaving her with an outstanding balance of $425,000. 

Since Sarah’s loan was funded, the rate in the wholesale market has fallen to 2% p.a. But her bank’s funding costs remain fixed at 5% p.a. That means her bank will lose money by allowing Sarah to break her contract.

In this scenario, the formula for calculating the break fee would look like this:

$425,000 x 2 years x 3% = $25,500

The final number will be a bit different after Sarah’s bank adjusts for present day value, as well as her repayment type (whether she was paying principal and interest or interest only), but she can generally expect it to be within that ballpark.

It might be tempting to abandon your current loan in favour of a more attractive one, especially if interest rates have fallen since your fixed term began. But there’s always the chance that the penalties involved will outweigh any savings from switching.

In the end, the decision will depend on you and the specific circumstances you find yourself in, but as always it’s a good idea to explore all your options with your lender or an independent financial advisor.

Looking to take out a home loan or refinance your existing one? Visit our home loan comparison page, where you’ll be able to filter your search by rate and type.