The low interest rate environment has been good for home buyers and those wanting to refinance, while not being so good for those who live on their savings. Another group of people displeased with the falling cash rate has been those who fixed their home loans around two years ago.
Back then – in 2011, when the cash rate was 4.75 per cent – banks were offering 3-year fixed rate mortgages around 6.3 per cent, and many borrowers did better than that.
Who was to know the Reserve Bank would get to the end of 2011 and almost half the cash rate over the next two years?
People with 3-year fixed rate mortgages taken in 2011 are still paying 6.3 per cent to be fixed, while variable rate mortgages are around 4.8 per cent.
On a 350,000 home loan, that’s a monthly repayment difference of more than $300.
Even the lucky ones who got in on the 5.99 per cent fixed rates are now paying a full 1 per cent over the variable rate.
So should people with eight or ten months left to run on their fixed-rate mortgages bail out and take a variable rate instead?
In the financial services industry, we call this a ‘break’. Banks tie their fixed rates to the bond and ‘swap’ markets. And these markets are run on terms of debt: 30-day, 90-day, 1 year, 3-year etc.
If you want to stop paying your fixed rate mortgage before your 3-year term is up, someone has to pay for that ‘break’, and it won’t be the bank.
Fixed rate mortgages include a page dedicated to the ‘break fee’. This is a number formulated on the size of the fixed loan, the term left on the loan and the profit the lender loses having to close-out your loan and accept lower rates in the market.
Your first job is to have the bank give you this number.
Then you must calculate the size of the break fee versus what you can save by moving to a variable interest rate.
There are a couple of tips I can give: firstly, always negotiate with the lender when thinking about breaking a fixed loan. All lenders are different and some will give you concessions on the break fee if you’re rolling over into a loan at the same institution.
Secondly, most lenders will allow you to roll your break fee into your refinanced loan, so long as you have the equity. This might suit you for short-term cash-flow reasons but remember that if you do this you’ll be paying interest on your break cost for years to come! So, this leads to my third point: if you do break and go to a lower cost loan, think about keeping your repayments the same. It’s a great way to speed your repayment of the loan and wipe that break fee.
As with everything financial, ensure you have accurate market and technical information. An expert adviser such as a mortgage broker could be a good place to start.
* Mark Bouris is the Executive Chairman of Yellow Brick Road, a financial services company offering home loans, financial planning, accounting & tax and insurance. Email with any queries you may have or check for your nearest branch.