For anyone that has a mortgage, it’s important to understand all aspects of it and how to avoid any unnecessary fees from the lender.
If you wish to pay off your mortgage early – or refinance or restructure your mortgage – you will likely be charged an early repayment fee by your bank. This is also referred to as a prepayment fee or a break fee.
Typically, an early repayment fee applies if you make any changes that break the current fixed contract of your loan.
The fixed contract is different from your ‘term loan’. Term loan refers to the duration of your mortgage, e.g. 25-30 years. Your fixed contract refers to your fixed interest rate, e.g. one year fixed at 3.39%.
If you decide to lock your loan in for one year fixed at 3.39%, but in six months decide that you wish to pay the loan off in full, the bank will charge an early repayment fee. That’s because, by paying the loan earlier than the one year fixed period, you're breaking your fixed contract.
Are early repayment fees fair?
In most cases, the early repayment fee covers a real cost for banks. When you break your loan, your bank will still have to pay their lenders for the interest they now won't be earning on your loan.
Are there any exceptions?
If the going market interest rate is higher than the fixed-term rate you were locked in at, there's a chance the early repayment fee won’t occur.
For example, if you fix for 3.39% for one year, but decide to break the loan, and the going market one-year rate is now sitting at 3.65%, you may be exempt.
Another situation where the early repayment fee doesn’t apply is if your loan is on a floating term. When your loan is on floating, you're paying significantly higher interest but you have the flexibility to make lump sum payments, pay in full, refinance or restructure without incurring a break cost.
Do banks ever waive early repayment fees?
A common misconception is that banks will pay or waive your early repayment fee. There are times that banks appear to look like they're doing so, but in truth, this never happens.
Sometimes, banks will offer cash contributions to attract new business, which may help to indirectly offset an early repayment fee. However, cash contributions are declining.
In the past 24 months, as interest rates and the OCR continue to drop, bank margins are also declining, and therefore we see lower and lower cash contributions.
Two years ago, banks would have easily given you $5,000 of cash contribution with a $500,000 mortgage. Today, cash contributions generally hover around $2,500 - $4,000.
Avoiding early repayment fees
In some situations, you can't avoid an early repayment fee. If you win first division lotto and would like to become mortgage free by breaking your loan early, you will probably do it!
However, a great way to minimise your run-in with a break fee is to have a clear mortgage structure that’s suited to your situation.
Your mortgage set up might be unique or straightforward, but it needs to come from someone with experience and knowledge to take the time to understand your situation. A good mortgage is more than just rates.