Is it worth breaking your fixed rate home loan?

Are you currently on a fixed rate home loan and considering breaking your fixed rate? Or are you worried about rising interest rates and considering breaking your existing fixed rate to lock in another for a longer period, before rates rise again?

In this article, we explain what it means to break a fixed rate home loan, the pros and cons, as well as what you can do to make a smart decision for you and your home loan.

• Related: How does the RBA cash rate affect home loan repayments?
• Related: How to prepare your home loan for rising rates in 2022

What does it mean to break your fixed rate home loan?

A fixed rate home loan is as it sounds – a home loan interest rate that is in place for a fixed period of time. Unlike a variable interest rate which fluctuates, a fixed interest rate remains the same for a specified period of time.

If you have a fixed rate home loan and do anything that goes against the terms and conditions of your contract during the fixed period, you are essentially ‘breaking’ your fixed rate.

Some ways you can break your fixed rate, for example, include:

• Switching to another lender or home loan product
• Switching to a variable rate home loan
• Refinancing your mortgage
• Paying off your home loan before the end of the fixed term
• Making extra repayments on your home loan beyond the cap set out in your contract.

What are the benefits of breaking your fixed rate?

It’s difficult to predict what will happen in the economic market and how your financial circumstances might change.

In some instances, it might be a good idea to break your fixed rate, but it’s important to speak to a Home Loan Specialist or financial adviser to weigh up the pros and cons to ensure you’re coming out on top.

A few of the benefits of breaking your fixed rate, under the right circumstances, may include:

• Accessing a lower interest rate if variable interest rates are lower than the rate you locked in
• Switching to a variable rate to access certain home loan features i.e. a redraw facility or 100% offset account, making unlimited extra repayments and no break fees
• Splitting your home loan to access the benefits of both a fixed rate and variable rate home loan
• Breaking your fixed rate if you’re nearing the end of your fixed term to lock in another interest rate before rates rise further.

What are the drawbacks of breaking your fixed rate?

As we mentioned earlier, breaking your fixed rate could incur substantial break costs. That’s why it could be a good idea to get in touch with an expert to make sure you’re saving in the long term.

Some of the drawbacks of breaking your fixed rate include:

• Break costs
• There is no certainty with your repayments if you are no longer on a fixed rate
• You may experience higher mortgage repayments if your new rate is higher than the fixed rate you locked in.

Why do lenders charge borrowers break costs if they break the terms of their fixed rate home loan?

When you lock in a fixed rate with your lender, they’ll need to source those funds from the market at wholesale interest rates. This relies on you sticking to the terms and conditions laid out by your lender in your home loan contract until the end of your fixed term.

If, for example, you break these terms by making extra repayments above the set limit and wholesale interest rates change, your lender could incur a loss.

Break fees are charged simply to compensate the lender for the loss incurred when you switch to a different lender or pay your loan early during the fixed rate period.

How much will breaking your fixed rate cost?

Each lender may use a different formula and consider different factors to decide their fixed rate break costs. Your lender should have provided this information in your home loan contract, but if you’re unsure, it could be helpful to get in touch to confirm with them.

The factors that are typically taken into account when calculating break costs include:

• The time left on your fixed rate period
• Your fixed interest rate compared to the current market interest rate
• The amount you borrowed from your lender.

How to calculate a break cost

Let’s take a look at an example to better understand how break costs are calculated. For this example, let’s use the following formula:

Let’s say your home loan amount is $400,000 and you’ve locked in a fixed interest rate of 2.55% for 4 years. After 2 years, you decide to break your fixed rate because you’d like to add an offset account to your home loan.

Interest rates have since dropped from the time you locked in your fixed rate to 2%.

Let’s slot this into the formula we saw earlier.

Break cost = $400,000 (loan amount) x 0.55% (change in interest rate) x 2 years (time remaining on fixed period) OR 400,000 x 0.0055 x 2

So, in this instance your break fee would total $4,400.

Should you break your fixed rate to lock in another rate before rates rise?

Whether it’s a good idea to break your fixed rate will really depend on your situation, needs and what you want to achieve with your home loan.

It could be beneficial to break your fixed rate and lock in another if you’re nearing the end of your fixed term. But it might also be more cost-efficient to wait it out, if you have the option to do so and if the break costs you incur are substantial.

If you’re rolling off your fixed rate soon, you will likely revert to your lender’s standard variable rate when your fixed term ends. This rate will be dependent on the package and product you settled on.

Typically, this standard variable rate won’t be as low as the rate your lender is offering to their new customers, which is often referred to as ‘loyalty tax’.

Is now the time to lock in a fixed rate?

Sam Hyman, Inside Sales Director at Lendi says, “the fact that fixed rates have been trending up means that break costs have been coming down. It may be a great opportunity to break that fixed rate and lock in a rate if certainty is what you’re after.”

Fixing your interest rate is beneficial if you want a high level of certainty when it comes to your home loan repayments.

Although fixed rates are generally higher than variable rates being offered currently on the market, it could also work in your favour to lock in your rate if the Reserve Bank of Australia (RBA) continues to increase the cash rate.

There are some competitive variable rates currently on offer as well, but these come with a level of uncertainty as it’s likely we’ll continue to see rates rise this year.

Even if you don’t plan on breaking your fixed rate, if you’re around 6 months from the end of your fixed term, it could be a good idea to speak to a Home Loan Specialist. They can help you figure out what to do once that time comes around, so you aren’t stuck with an uncompetitive rate.

There are also several cashback offers for refinancing your home loan, which can offset some of the costs typically associated with refinancing.

What you do with your home loan is up to you, and different courses of action will work better for different people and preferences. That’s why it’s a smart move to reach out to a Home Loan Specialist who can help explore your options and find out what will suit your needs and circumstances.

What could your home loan repayments look like?

Got a home loan question? Just ask!

We're here to help. Get free expert advice at a time that suits you. Choose a time to chat with a Home Loan Specialist here

The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.