What are break costs?
Break costs are a fee charged by lenders when you make extra repayments on a fixed rate loan. Most lenders will allow you to pay a small amount off your loan each year without being charged, however if you go over this amount or pay off the loan entirely then you will be charged this fee.
Banks are not very good at disclosing their break fees or how they will be calculated! For this reason we've created this easy to follow guide for anyone considering a fixed rate loan.
What other names do lenders use?
Different banks use different names for their break costs. Some common names include economic costs, exit fees, early repayment adjustment or prepayment fees. Often your bank will not know what you are talking about unless you use their terminology:
- Commonwealth Bank (CBA): Early repayment adjustment (ERA).
- National Australia Bank (NAB): Prepayment fees and economic cost.
- Westpac (WBC): Break costs.
- Australia and New Zealand Bank (ANZ): Early repayment fee (ERF).
- St George Bank (SGB/StG): Break costs.
All of these different names refer to the same fees for paying off part or all of a fixed rate loan early.
How much can I repay without break fees?
That depends on which lender you are using! The major banks are relatively inflexible with extra repayments on their fixed rate home loans, however some building societies offer flexible fixed rate loans with unlimited additional repayments:
- Commonwealth Bank (CBA): $10,000 per annum.
- National Australia Bank (NAB): $20,000 per annum ($0 for some loans).
- Westpac (WBC): $15,000 per annum.
- Australia and New Zealand Bank (ANZ): $5,000 per annum OR 5% of the loan amount, whichever is the lesser.
- St George Bank (SGB/StG): $10,000 per annum.
IMPORTANT: Because banks change their policy from time to time this information is current only as of the time it was written. You should always check with your lender just to be sure. This is a guide only!
Why do banks charge this fee?
When a bank funds a fixed rate loan they borrow money from the wholesale money markets. Their interest rate is locked in at the same time as yours. However they do not have the option to repay their loan early, so when you repay yours they have to lend the money to someone else but may still be paying a high rate on their loan.
If the cost of borrowing money on the wholesale market has fallen between when you fixed your rate and when you pay off your loan then the bank has an "economic cost" to carry until their loan is ready to be repaid. They pass this cost on to you as break fees.
How are break costs calculated?
They are calculated by working out the difference between wholesale rates between the time when you applied for your loan and when your loan is repaid and multiplying it by the loan amount and the remaining term of the loan.
There is no exact formula as each lender has their own specific method of working out the fees they will charge you. The formula used should be listed in your loan contract / loan offer. An example formula would be:
Break fee = Loan amount x Remaining fixed term x Change in cost of funds
Because the term of the loan is used in the calculation, break costs tend to be very high for 10 year or 15 year fixed rate loans and larger home loans.
Also if rates have increased since you fixed your loan then there is a good chance that you will not be charged exit fees for breaking your fixed rate contract because the bank would actually make money from your paying off your loan early! Some sneaky banks will try to charge you fees anyway, so be careful and ask them how they are calculating the fee or by how much the wholesale market interest rates have changed.
Are the banks ripping us off?
Possibly! The banks don't tell you what their current costs of funds are, so it is difficult to be sure that they are doing the break fees calculation correctly. We have received reports that some banks are purposely manipulating the break fees that are charged. They do this by using the different between the rate you have and their current wholesale rate rather than the wholesale rate when your loan was advanced and the current wholesale rate.
By doing this they can get away with charging you additional break fees without you knowing about it. If you are worried that your bank is trying to rip you off then make a formal complaint and ask them to explain in detail how they are calculating their early repayment penalties.
Example break cost calculation
Example: John has a fixed rate loan of $300,000 with ABC Bank. He fixed his rate at 6% for 5 years. After 3 years John sells his property and repays his fixed rate loan in full. If wholesale interest rates had dropped by 1%, how much would John pay in break fees?
Break fee = Loan amount x Remaining fixed term x Change in cost of funds
Break fee = $300,000 x 2 years x 1%
Break fee = $6,000 approximately
IMPORTANT: This is an example only, you should refer to your lender for exact break fees. As a general rule if you had a 6% fixed rate and the lender is now offering 5% fixed rates for the same term then it is likely that wholesale rates have dropped by 1%. This is not always accurate.
Avoid break costs with a flexible loan
Did you know that some loan types allow you to make unlimited additional repayments with a fixed rate, without penalty? As long as you do not close your loan, you can use a flexible fixed rate to enjoy the extra repayments of a variable interest rate without the uncertainty of interest rate fluctuations.
