This is a common issue among borrowers who chose to fix the interest rate on their home loan when rates were high. Fixed rates attract higher break costs than regular standard variable rates and these break costs can end up being in the tens of thousands of dollars.

Whenever you fix the rate on your loan, you are betting against the market. You are confident that the rate that you have fixed will not go above the standard variable rate, and sometimes this is the case. But in the past, with the effects of the global credit crunch forcing rates down, many borrowers just could not see it coming.

Unfortunately, there is not a lot you can do. One possible way to reduce interest on your loan is to pay more off. Most fixed rate loans do not allow extra repayments, but some do allow them in lump sums and others allow for more regular amounts.

You will have to ask your lender if it will allow you to make extra repayments on your fixed home loan without any additional charges.

Why do lenders charge break costs?

When you enter a fixed-rate term, your financial institution obtains money from the money market at wholesale interest rates, based on the assumption of a fixed rate over a fixed term.

Given that wholesale interest rates change daily, changes could potentially be significant. To recoup any potential lost revenue as a result of the wholesale interest rate being lower at the time you break your fixed term, financial institutions charge break costs.

Typically, banks and lenders do not necessarily profit from charging break fees, given that they only charge these to recover any potential revenue loss.

How are break costs calculated?

Break costs are not fixed — they are often calculated based on your outstanding balance, the remaining years of your fixed term, and the difference in wholesale interest rates from the onset and the termination of your fixed term.

Lenders have different ways to calculate break costs but they usually follow a general formula that looks like this:

Break costs = Home Loan Amount * Remaining Years on your Fixed Term * Rate difference

Is there any other way to avoid break costs?

Unfortunately, there is no other way to avoid break costs but to finish your fixed-rate contract.

You can ask your lender for special arrangements on the break costs but you will still have to eventually pay these charges.

If you want to avoid potentially incurring break costs but would still like to have the protection a fixed rate provides, you have two options: choose a shorter fixed-rate term or get a split loan.

A shorter fixed-rate term of two to three years would be enough to cover any potential rate rise and provide certainty — you will just need to re-fix your loan once the term lapses.

Meanwhile, you can also choose to have a part of your loan be charged with a fixed rate while the other is on a variable rate. This way, you will be able to enjoy the best of both worlds.

Collections: