Should I break my fixed rate?

Should I break my fixed rate?

With big changes in interest rates over the last few months, many people currently on fixed rates may be looking with envy as new fixed rate offers drop into the low 2’s.

We’ve received lots of calls and messages recently form borrowers currently locked in to fixed rate contracts to see if there is any option to switch to a new lower fixed rate as the savings can be significant.

The recent rate decreases and emergency rate cut due to the RBA’s Covid-19 economic response saw many lenders make significant drops to their fixed rates.

Our broker Paul Fox explains “This time last year the lowest three year fixed rate was 3.49% and this week it stands at 2.14%. The difference in rate makes the new fixed rate approximately $278 per month cheaper on a $400,000 loan, which is a big saving”

Before you get excited though, if you have a current fixed rate your lender will charge you a fee to break it. There are differing calculations, below is the one Westpac use!

Extract from Westpac Break costs fact sheet

The above may require access to a mathematician, but in general they will calculate the break costs by multiplying the loan amount remaining to the remaining fixed term and then the change in the the Bank Bill Swap Rate (BBSR) for that day (yes, it can change daily!). The longer you have on your fixed term remaining, the higher the break costs could be.

Example*: a $400,000 home loan with a fixed rate of 5% over five years and the BBSR is 5%. Four years in you wish to refinance to a lower rate, resulting in a break.

The loan now has a balance of $374,520 and one year remaining. The BBSR is now 3%.

$374,520 x 1 years x 2% (difference in swap rates) = $7,490

The bank may also then reduce the fee based on your repayment option (principal and interest or interest only).

above example is for illustration only.

Once you have your break fee, it’s important to calculate correctly the cost over the term you have outstanding on your fixed period and not the period of the new fixed rate.

The difference in payments switching the above to a 2.14% three year fixed rate would be around $581 per month (based on lower loan term and new balance), meaning a saving of $6,972 over the remaining fixed period. Factoring in switching costs of around $750 (estimated discharge and mortgage fees) means overall saving would be $6,222 it looks like switching would not make a saving but actually a loss of $1,267.

However, if the existing repayment of $2,148 was made per month the loan balance after a year would be $367,315 if you stayed on the 5% rate and $356,556 if you switched, means a saving of $10,759. Factoring in the break fee and estimated switch costs of $8,240 you would be better off by $2,519.

above example is for illustration only.

Paul says “Don’t rush into breaking your fixed rate as it could end up costing you thousands and take note that fixed rate break fees are only valid for a short period of time, so you may see them change significantly in the matter of days. Another factor to consider is that if you are looking to switch to another lender it’s important that you get a valuation done as with the recent fluctuations in the market you may find that you could incur lenders mortgage insurance.

“If you do need help then get in touch with us or your local broker and they will be able to assess your situation fully and provide you with options.”

*The above rates and examples quoted are for illustration purposes . Your full financial situation would need to be assessed prior to any offer of finance.