Managing your mortgage can be a bit of a headache. Many of us just let the bank deal with rollovers but there can be a big financial benefit of breaking your fixed term home loan to refix or refinance.
Why would you ever break a loan?
Typically you refix your loan at the end of your loan term, but it can make sense to break a loan and refix for a long term benefit. You may refinance your loan if another bank is offering you better rates and you may receive an immediate cash contribution from your new bank. To understand if you should break your loans we have made this handy refinance calculator. I’d recommend giving it a go and if you are interested in how it all works, carry on reading.
So what are the benefits of breaking?
If interest rates have dropped since you started your loan or are better at a different bank you can save on interest. For example, with a loan of $500,000 an interest rate change of 0.5%p.a. is a saving of $2500 per year.*
If you move to a new bank they will often provide you with a cashback. This can be a significant value, often about 0.6% of your loan. With the same $500,000 loan this could be $3,000 cash immediately.* Important to note here though is that if you received a cashback within the last 3-4 years and you want to refinance, your existing bank may clawback some or all of this cash payment.
There is always a flipside
When you break a loan early to refix or if you refinance your loan could incur a break fee. A break fee is a cost that the bank incurs when they break a fixed term loan and this cost is passed on to you. Just like we get money from the bank, the bank gets money from investors and if they make a loss, that loss gets passed along to the customer in the form of a break fee. A fee for the administration of the fixed rate break may also occur.
Additionally if you are refinancing you may also incur an administration fee for the fixed rate break. You may also incur legal fees to transfer your title as security across to your new bank.
To make your decision you typically end up with the following equations
Benefits – Costs = Total Savings
(Interest Savings + Cashback) – (Break Costs + Clawback + Bank Fees + Legal Fees) = Total savings
Interest Savings - Break Costs = Total Savings
So when should you break your loan?
As you will have noticed, break costs are the key to the decision to break your loan. Often you might find that the costs to break your fixed rate loans will be lower at the bottom of the interest rate cycle and on the way up. It’s often most expensive to break when interest rates are falling. Refinancing, or breaking your loan is a part of a wider financial strategy - it may work for now, but make sure it makes sense long term!
Try out the break fee calculator and if the costs are low enough, get in touch to refinance your mortgage.
*It’s important to note that the examples given in this article are indicative only and actual savings amounts may differ.