The world is feeling like a more positive place… Well that’s what it feels like on my side of the desk anyway with inflation almost under control, a surprise drop in the OCR by the RBNZ, and the sudden and large interest rate drops by banks follow the OCR drop. The conversations I am having with clients are of shock of how suddenly and how far the banks dropped their interest rates post the OCR drop and general positivity, with people taking a deep sigh of relief as the overarching expectation is that interest rates will continue to fall.
Looking into the Lateral Partners crystal ball, we also predict that interest rates will continue to fall for the foreseeable future, and as they fall people are going to be questioning whether they should stay on their current interest rates and ride them out until their refix date, or if people should look to break their interest rate to fix on a lower offered interest rate…. My colleague Jay wrote a great blog talking about some considerations you should have in the current interest rate (decreasing) environment.
In this blog I am going to explain what break fees are, how they can affect you, and a couple of examples to guide you into whether it is worth breaking your current interest rate or not.
What are break fees?
Break fees, also known as early repayment adjustments, are charges imposed by banks when a borrower decides to pay off their mortgage or change their interest rate during the fixed term of their current interest rate.
Why Are Break Fees Charged?
Banks charge break fees to cover the financial loss they incur when a mortgage is repaid or an interest rate is changed. This loss occurs because the bank has committed to lending the money at a fixed interest rate for a specific period and contracted the other side of this arrangement. If the borrower then decides to repay the loan early or change their interest rate, the bank may have to re-lend the money at a lower interest rate, especially if market rates have fallen as they have the past few weeks, meaning the bank loses out.
How Are Break Fees Calculated?
The calculation of break fees is complex and varies between banks. Generally, break fees are a percentage of the remaining mortgage balance and depend on factors such as the remaining term of the mortgage and the difference between the original interest rate and the current market rate.
Some banks use specific formulas to determine the exact amount, which can make it challenging to predict the fee without consulting the lender directly.
Websites like Interest.co.nz have a calculator which can give you a rough idea of what your break fee may look like, but this is not 100% accurate so don’t be surprised if what the bank tells you is more or less than what the below linked calculator tells you.
When Might You Encounter Break Fees?
As above, break fees are incurred when you break the current fixed term of your mortgage through either repayment of debt or canceling of the fixed rate. Below are some scenarios you might face break fees, such as:
- Selling Your Property: If you sell your home before the end of the fixed term, you may need to pay break fees.
- Refinancing: Switching to a new bank/lender or mortgage product before the fixed term ends can trigger break fees.
- Early Repayment: Paying off your mortgage early, either through lump-sum payments or accelerated payments, can also result in break fees.
- Switching interest rates: If you wish to switch you interest rate to a new one during the fixed term of your current interest rate, most likely to happen if interest rates have dropped.
A crucial thing to note is a lot of the time the banks will require you to pay these break fees up front in cash, however some banks may allow you to capitalise this fee into your loan.
Is it worth me breaking my current fixed interest rate?
Now this is a bit of an ambiguous question to answer… It really depends on each individual person, their financial position, their current mortgage balance, their current fixed term interest rate, and the new interest rate they wish to refix on, so always consult your Mortgage Adviser or bank before you go and break your loan!
I am having a lot of mortgage break conversations nowadays in light of the dropping interest rates and I try to assist by giving a rough indication of the break costs and guiding clients into whether it is worth it or not, but in reality, the banks have the secret recipe… they know the 11 secret herbs and spices and will be able to give you an accurate idea of what the break fees will look like. Useless mortgage adviser I know!
Of course, as Mortgage Advisers we can assist in approaching the bank to get a quote in regards to your mortgage and it’s break fee and then advise appropriately. So maybe not that useless after all!
I am a big believer of examples and providing some sort of idea or information to clients so that they are better informed to make a smarter decision and when they speak with their bank.
So, let’s look at a couple of examples, with the first example using my own mortgages as a case study.
Note; These examples below are purely to give an indication and are not financial advice as each person’s situation should be assessed different depending on their financial needs and goals.
My mortgage is split into 3 portions, 2 coming off at the end of the year, and 1 coming off in June 2025.
The original loan structure was 1/3 of the mortgage fixed for 1 year which was refixed for 18 months and then again in the middle of this year for 6 months for 6.89% with the expectation that rates would come back at the end of the year, 1/3 fixed on the 2 year interest rate, which was refixed for 18 months at 6.98%, and 1/3 which was fixed for 3 years at 4.39% which is coming off at the end of this year.
The portion I would consider breaking to refix on a lower interest rate would be the 18-month fixed for 6.98%.
Using the calculator on Interest.co.nz and inputting my mortgage information for this portion of my lending and the date I would like to break this loan also called the ‘Date of prepayment’, we can see that my expected break fee would be $1,658. As we shift the date later or closer to the date of my refix (in my case the 9th June 2025) then the expected break fee lowers as the bank doesn’t lose out as much (depending on the movement in interest rates between now and then – if rates continue to fall then it might keep going up / stay the same).
However, we need to look at the cost comparison of the break fee vs how much I would save if I refixed on the current 1 year or 18-month interest rate.
Note: Shorter term rates have been considered with the outlook that interest rates will continue to fall. Also, the 6-month interest rate has not been considered here as the current interest rate is 6.85% so not much better than my current interest rate.
Currently the best 12 month and 18 month interest rates offered by the banks is 6.29% & 5.90% respectively.
If we consider the break and refix date to be the 12th Sept 2024 my loan balance at this time will be $239,293.28.
We can then compare the fortnightly/FN (my repayment frequency) interest costs of these different interest rates scenarios and terms.
Note: These interest cost calculations are not amortized like a mortgage usually would be calculated but gives an average cost calculation.
9-month difference is the interest cost difference between 12th Sept 2024 & 9th June 2025, which is also 19 fortnights away.
We can see from the comparison table above that the interest cost savings over the next 9 months if we changed to the current 1-year interest rate isn’t enough to justify breaking our current interest rate term as the break fee ($1,611) is larger than the interest cost savings ($1,207.07). However, if we changed from our existing 18-month 6.98% interest rate to the current 18-month 5.90% interest rate, we are better off $231.36 over the next 9-months (difference between the break fee & the 9-month interest cost savings), so it would be worth considering breaking our current interest rate term.
That was a short-term interest rate example with a reasonably low loan amount, but what happens if someone has a larger mortgage on a longer-term interest rate. What will the break fees and cost difference look like then?
Consider Joe Bloggs who has a $1m mortgage with an interest rate of 6.39% fixed for 5 years which commenced the beginning of this year (12th Jan 2024), but Joe wants to break his loan now that interest rates have dropped. What would the break cost be?
We can see that the break costs as calculated by the Interest.co.nz calculator equal to $26,476! A significant amount of money but it is our benchmark for this comparison.
By the 12th Sept 2024 the loan amount will be circa $991,509.13, so using this we can calculate the interest cost differences and savings.
We can see that it is not going to be worth Joe breaking his loan to refix on 1-year, 18-month, or 2-year interest rates, but it becomes worth it for him to break his loan to refix on any of the current interest rates 3 years and above, however with interest rates expected to fall in the next 6 months to 2 years the new interest rate he breaks his loan and refixes onto today (3+ years) may not be as attractive in the future retrospectively.
Breaking your mortgage isn’t just about the numbers, although this is the biggest driver for doing so. There are factors like a client’s plans and goals, financial position changes, bank policies, lending factors, and economic factors which can affect a person breaking their loan either positively or negatively and your Mortgage Adviser is there to help and guide you through the best possible solution, so please speak to them before you take the next step! Yes, I am biased, but why wouldn’t you engage them when the bank pays them for assisting you!
If you have any questions, please don't hesitate to reach out!
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