This month’s case study looks at a client that asked us to investigate breaking their current interest rates in order to restructure their mortgage.
The clients – let’s call them Jack and Jill – had their mortgage spread over several accounts that had accumulated over a few years. They had a mix of investment property and “owner-occupied” property and really wanted to tidy up their accounts. This would make tax deductions a lot clearer for their Accountant, not to mention just less financial confusion all around.
Their average interest rate (over all accounts) was at around 4.65%. No mortgage account had more than 2 years left until it matures (although some had originally been a 3 or 4 year fix at the time).
When you fix a mortgage account with the bank, you are promising to borrow a certain amount of money for a certain amount of time. As an example, you may have fixed $100k of your mortgage for 2 years at 4.65%.
A year later, you may look at this rate and regret the decision (it happens to the best of us!). Let’s say the 1 year rate is now 3.99%. How much is it going to cost you to break the fixed rate and refix at the new lower rate? In other words, what will the break costs be?
A very simple way to estimate the break costs is to find the interest rate difference. In this case, the difference is 0.66% (4.65% minus 3.99%) and the rate has a year left. We could expect the break costs to be at, or around, $660 for $100,000 mortgage.
The only way to get an exact break cost is to ask the bank to calculate it. The amount is only valid for that day as it is recalculated on a daily basis so there is a margin of error if you break the fixed account a little later.
Back to our clients – Jack and Jill. Their average mortgage rate was 4.65% and their bank informed us that the break costs would be $11,923. That means the clients are going to have to find almost $12,000 to break their rates. That’s a lot of money but how much will they save?
A quick calculation showed that they would save $13,703 in interest payments over the next year. In other words, they are saving almost $2,000 once the break costs are factored in. This doesn’t take into account the tax benefits of restructuring their accounts. In the end, they are looking over $5,000 better off in the next year.
Is it worth paying $12,000 today to be $5,000 better off over 1-2 years’ time? It depends on whether you have $12,000 available but it is certainly worth considering and investigating.
Could our clients top up their mortgage by $12,000 if they didn’t have the break fees available? The short answer is yes, but you wouldn’t want to pay that $12,000 over the entire length of the mortgage. The compounding interest on that would make it a bad decision.
But they could top-up the mortgage and pay it off over the fixed period (2 years).
The money flow in it’s most simple form is:
The Mortgage Lab has a calculator (ok, it’s just a pretty Excel Spreadsheet) that will quickly calculate the savings you’ll see if you break your existing mortgage and refix at today’s rates. We can also request the total break costs from your bank. The banks receive these all the time and there is no cost to asking for an estimation.
calculator spreadsheet will tell you how much you’ll save over the remaining term of the fixed period.
All you need is:
Contact a Mortgage Lab adviser to ask them to complete a break cost calculation.
The record break cost fee for our company currently stands at $54,481 however the interest rate savings was a total $83,464 meaning a net savings of $28,983. This was in a market of quickly falling interest rates (2015) and the clients ended up going ahead with this restructure (~$30k is a hard profit to turn down!).
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