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In the remaining months before your fixed expiry date the bank will be expecting to receive in interest, breaking your fixed mortgage will cause them to loose a portion of this, which is why the break cost is charged
The bank will charge you break fees if you break the fixed term contract of your mortgage. For example, if you have fixed your mortgage for 2 years, and decide after a year you’d like to repay the loan, or refinance to another bank, there is most likely going to be a break fee involved. The ‘Break Fee’ or “Early Repayment Cost” is the bank’s way of recouping the interest they expect you to pay on the fixed mortgage. Because they borrow money offshore, usually on a fixed rate, they need to recoup enough from you as the client to repay this ongoing obligation.
Break Fee = Loan Amount * (Fixed Interest Rate - Market Interest Rate) * Remaining Term
Therefore, if you’re looking to break your mortgage during a fixed term, and rates have risen, above your fixed rate significantly, there’s the chance your break fee will be small, or non-existent. If rates have fallen, the break fee will balloon.
For example, if you wish to repay your $500,000 mortgage early, and the fixed interest rate is 5.5%, while the wholesale market interest rate is 4.5%, and your fixed rate expires in 1 year, your break fee will be the following:
$5,000 = $500,000 * (5.5% - 4.5%) * 1 year
The important thing to remember about your break fees is that they aren’t nearly as scary as they seem. If your break fee is HUGE, your potential interest savings from getting onto the market prevailing rate is also HUGE. It’s more important to re-assess it with you adviser and see if breaking your mortgage makes sense based on your personal goals, and the direction future mortgage rates are headed.
It’s also important to note that most banks keep the actual break fee calculation hidden. We’ve developed a break fee calculator that’s been refined over the last 2 years to most accurately reflect the results we’ve received for our clients. Enter your details and calculate an estimate of your break fees.