How To Calculate Break Costs And Decide If It Is A Good Strategy

For the past 12 years, interest rates (both mortgage and the Official Cash Rate) have been decreasing.  That means that almost everyone who has fixed their mortgage at some point in the past 12 years has had “fix regret”.  Recently, for example, you might have fixed at 3.35% for 2 years only to see the rate drop 3 days later to 2.99% (True story because that’s exactly what I did).

To get out of this fixed interest rate, you’re going to need to ask the bank to renegotiate the contract you have signed.  And if the rates have gone down, you’re probably going to get a Break Fee.

How do banks calculate a break fee?

A break fee should, in theory, be the difference between the rate you were fixed at and the new rate.  But the calculations are quite a bit more complicated than that.  They involve the Wholesale Swap Rates which are largely reflective of the NZ Government Bond Rate as well as supply and demand.

Believe it or not, this is actually good news.  Because using the Wholesale Swap Rates and not just the difference in mortgage interest rates means the break fees can mean breaking your fixed-rate loan can come out in your favour.  In fact, the current record break fee that we have processed was $54,481.  It sounds a lot (and it is!) but we calculated the customer was saving $83,464 on interest over the period, so a net benefit of $28,983.

One thing to know about break fees though is that the banks cannot make a profit from them.  So whatever fee they charge is the cost to them, not the bank scalping you for wanting to change.

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How do I know if it's worth paying a break fee?

There are 3 things you need to know to be able to decide whether to break your current rate or not:

  1. How much are you going to save on mortgage payments if you break?
  2. How much is the break fee going to be?
  3. Can you afford to pay the break cost upfront?

A real-life example of break costs

Jack and Jill are our clients.  Their average mortgage rate over all their accounts was 4.65% and the 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.

Is it worth paying $12,000 today to be $2,000 better off over 1-2 years' time?  It depends on whether you have $12,000 available but it is certainly worth considering and investigating.

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Can I top-up my mortgage to pay for break fees?

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:

  • apply for a top up on the mortgage by $12k
  • break the fixed rates and pay the break costs
  • continue to pay the same payments as before
  • in 2 years, the mortgage will be $2,000 lower than it would have been if the current rates had remained in place

Are there any Solicitor fees from break fees?

It would be very unusual for a Solicitor to be involved with a break cost.  There is no change required to the Title of your property and is just a change between you and the bank.  You will most likely need to sign new documentation at a bank branch.

If you break a rate, do you refix the money for the same term?

If you had 8 months left on your fixed-rate and decided to break, do you automatically refix for the nearest term (6 months or 1 year)?  Absolutely not!  Breaking your rate gives you the freedom to completely reassess your mortgage structure.  Although the 1 year might be the cheapest, it might suit your financial situation to lock your rate in for 2 years or more.  Here's an article we wrote on 3 questions to ask when you're refixing.

Is it worth breaking your mortgage?

The Mortgage Lab has a calculator (ok, it's just a pretty Excel Spreadsheet) that will quickly calculate the savings 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.

Our spreadsheet will tell you how much you'll save over the remaining term of the fixed period.

All you need is:

  • the balance and interest rates of all your fixed rates.  If you are a current client of ours, we may already have this information in our online system
  • sign an Authority and Declaration so we can get a break cost quote

Extra Payments Tool

Taking advantage of reduced interest rates but keeping the payments at the old rate can quickly reduce your mortgage. Below is an easy-to-use tool that will allow you to see how much you can save by making additional payments on your mortgage.

Contact us to get a break cost calculation on your mortgage

Mortgage Lab’s mission is to be the digital town square for financial decision-makers to gain knowledge about their current and future mortgage. Follow us on Facebook and LinkedIn or subscribe to our newsletter to be notified of our latest articles.

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