The Break Cost Formula on Fixed Loans

Key takeaways

• Break costs arise when wholesale rates FALL after you fix, not when they rise.
• The rough shape is: balance x rate differential x remaining years, discounted.
• Your lender must give you an actual figure on request - always get it in writing.
• Selling the property triggers it too, not just refinancing.

Why does breaking cost anything?

When you fix, the lender typically hedges its position in the wholesale market for the term of your fixed rate - it commits to receiving your fixed rate and manages the funding accordingly.

If you exit early, the lender has to unwind that arrangement. Where wholesale rates have fallen since you fixed, it can now only re-lend your money at a lower rate, and the difference over the remaining term is a real loss. The break cost recovers that.

Where wholesale rates have risen since you fixed, the opposite applies - the lender can re-lend at a higher rate, so there is generally no economic loss and the break cost is small or nil. This is why borrowers who fixed at low rates and then saw rates rise sharply often found breaking was cheap, while those who fixed at high rates before a fall face large figures.

What does the calculation look like?

Lenders use their own formulas set out in the loan contract, and the inputs are wholesale rates you cannot look up. The general shape is:

Break cost ≈ balance x (wholesale rate when you fixed - wholesale rate now, for the remaining term) x remaining years, discounted to present value.

Illustrative only. A $400,000 balance with 3 years remaining, where the applicable wholesale rate has fallen 1.5 percentage points since you fixed:

The sensitivity is worth noticing: halve the remaining term and you roughly halve the cost. That is why breaking in the final months of a fixed term is often inexpensive even when rates have fallen a long way.

What should you do before breaking?

1. Ask your lender for the actual figure in writing. Estimates from calculators are indicative; only the lender's number is real, and it changes daily with wholesale rates.
2. Ask how long the quote is valid. Break cost quotes are typically valid for a short period.
3. Compare against the benefit. The saving from a lower rate over the remaining fixed term, plus any other reason for moving, against the break cost plus other switching costs.
4. Check whether portability solves it. If you are moving house rather than refinancing, substituting the security keeps the fixed loan alive and avoids the break cost entirely.
5. Consider waiting. The cost falls as the remaining term shortens.

Two things borrowers are often surprised by: selling the property triggers a break cost just as refinancing does, and making large extra repayments above the annual cap on a fixed loan can trigger a partial break cost too.

Frequently asked questions

How much does it cost to break a fixed home loan?

It depends on your balance, the remaining fixed term, and how much wholesale rates have moved since you fixed. It can be nil if rates have risen, or many thousands if they have fallen. Only your lender can give the actual figure.

Why is my break cost zero?

Most likely because wholesale rates have risen since you fixed, so the lender suffers no economic loss from you exiting. Break costs generally arise only when rates have fallen.

Do I pay break costs if I sell the house?

Yes. Selling discharges the loan, which breaks the fixed rate contract in the same way a refinance does. Portability may avoid it where you are buying another property and the lender permits security substitution.

Can I make extra repayments on a fixed loan?

Usually only up to an annual cap set by the lender. Repaying above the cap can trigger a partial break cost, so check the limit in your contract before making a large lump sum payment.

Related reading

• Break Costs on Fixed Loans: How They Are Calculated
• How Swap Rates Determine Your Fixed Home Loan Rate
• Why Early Repayments Are Almost All Interest

Sources

• Moneysmart - fixed rate home loans — ASIC
• Banking Code of Practice — Australian Banking Association