When you have a ‘Fixed Rate’ mortgage, you commit to a ‘fixed interest rate’ for a specified term.
When your circumstances change, you may be placed in a position when you need to adjust your mortgage before the fixed period ends.
If this should happen, in such scenarios, Lenders typically impose a fee known as a “Break Fee” or “ERA” (early repayment adjustment), to compensate for their potential loss of interest income.
When we are in a reducing interest rate environment, clients often ask if they can break their current rate and lock in a lower one and if they do what if any penalties are there to consider.
gh understanding of mortgage break fees, their purpose, calculation methods, and strategies to minimise their impact. Read on!
Break Fees, Their Purpose and How to Minimise Their Impact
Break fees may seem like an unnecessary burden on borrowers. However, these charges serve a legitimate purpose for Lenders.
When a borrower breaks a fixed-term mortgage agreement, the Lender must terminate the funding arrangements it had secured with wholesale funders.
This termination by the Lender often means the Lender incurs penalties, as they are obligated to compensate their funders for the potential loss of interest income.
Passing on these costs to borrowers through break fees, Lenders maintain a fair balance between their interests and those of their borrowers.
Without such fees, Lenders would face substantial financial losses, ultimately leading to higher interest rates, or tighter lending criteria for all borrowers.
How Break Fees Are Calculated
Break fees are not a one-size-fits-all charge, as their calculation involves several factors and can vary significantly from Lender to Lender.
For example:
- The higher the remaining balance on your mortgage – the outstanding loan amount – the larger the potential break fee.
- Also the longer the time remaining on your fixed-rate term, the higher the break cost to you.
- The difference between your current fixed rate and the prevailing market rate for a similar term, is an important factor in determining the break fee amount.
- Lenders may include their administrative expenses associated with processing the mortgage break and establishing new loan terms.
Exceptions to Break Fees
In certain circumstances, borrowers may be exempt from paying break fees.
Such as when the prevailing market interest rate for a similar term, is higher than your current fixed rate at the time of breaking the mortgage.
So, if you initially fixed your home loan at 4.50% for two years and need to break the loan when the current two-year market rate is 5.29%, you may not be required to pay a break fee.
This would be because the Lender would not incur a loss by terminating your existing agreement, as they could potentially earn a higher interest income by re-lending your loan at the higher market rate.
Additionally, loans on a floating or variable rate term typically offer more flexibility, allowing borrowers to make lump sum payments, pay in full, refinance, or restructure without incurring break costs.
The exact formulas used by Lenders can be complex, however the underlying principle is to compensate them for the potential loss of interest income they would have received had the mortgage continued as initially agreed on the fixed mortgage rate.
Refinancing and Break Fees
A common scenario where borrowers encounter break fees, is when refinancing their mortgage.
Refinancing can be a strategic move to secure a lower interest rate, access additional funds for renovations or investments, or consolidate debts. However, it often involves breaking an existing fixed-rate term, which can trigger substantial break fees.
So, if considering refinancing, it’s essential to weigh the potential benefits against the costs, including break fees. The timing of your refinancing, if you are nearing the end of your fixed-rate term, may mean the break fee may be significantly lower or even negligible.
Selling Your Property and Break Fees
If you have a fixed-rate mortgage and plan to sell your property before the end of the fixed term, you may be subject to break fees.
When you sell your property, you are effectively breaking the fixed-rate agreement with your lender, as the mortgage will need to be paid off or discharged.
The Lender may therefore impose a break fee to compensate for the potential loss of interest income they would have received had the mortgage continued as initially agreed.
The break fee can be a significant expense, potentially impacting the net proceeds from the sale of your property. So to avoid any surprises, make sure to obtain an estimated break fee calculation well in advance of your intended sale date. This is where the expertise of a an iLender Mortgage Adviser can prove invaluable.
iLender can liaise with your Lender to obtain break fee calculations and guide you through the process of managing these costs effectively. We can recommend strategies to minimise the impact of break fees, such as timing the sale to coincide with the end of your fixed-rate term or exploring alternative options to enable you to avoid breaking the mortgage.
Break Fees and Mortgage Portability
Mortgage portability is a feature offered by some Lenders that allows borrowers to transfer their existing mortgage to a new property without incurring break fees.
This is particularly advantageous for homeowners who need to sell their current property and purchase a new one before the end of their fixed-rate term.
When you ‘port’ your mortgage, your Lender essentially transfers the remaining balance, interest rate, and terms of your existing mortgage to the new property. This can save you from having to break your fixed-rate agreement and help avoid substantial break fees.
Mortgage portability is not a guaranteed feature and may come with certain conditions and limitations.
Some Lenders may require that the new property meets specific criteria, such as being within the same geographic area or falling within a certain value range. Also, you may need to requalify for the mortgage based on your current financial situation and the value of the new property.
If the value of the new property is higher than your existing mortgage balance, you may need to obtain additional financing, which could be subject to different terms and interest rates.
It’s also important to note that even with mortgage portability, there may be instances where break fees are still applicable.
For example, if you need to increase the mortgage amount beyond the Lender’s portability limits, you may be required to break a portion of your existing mortgage, resulting in partial break fees. This is where working with a knowledgeable Mortgage Adviser can be invaluable when considering mortgage portability.
ILender can help you understand the specific terms and conditions of your Lender’s portability policy, as well as guide you through the process of transferring your mortgage to the new property.
How to Minimise Break Fees
It may not be possible to completely avoid break fees in certain situations; there are strategies you can employ to minimise their impact.
Firstly, you can optimise Your mortgage structure, as this can significantly reduce the likelihood of incurring substantial break fees. This involves considering factors such as loan flexibility, repayment options, and loan terms, in addition to interest rates.
By aligning your mortgage structure with your financial goals and anticipated life events, you can minimise the need for costly adjustments down the line.
Secondly by dividing your mortgage into multiple portions with different fixed-rate terms, can provide greater flexibility. If you need to break one portion, the remaining portions can continue unaffected, potentially reducing the overall break fee.
In summary by working with a knowledgeable Mortgage Adviser at iLender you can rest assured you will be provided with invaluable insights and guidance in managing break fees and optimising your mortgage structure. We can help you navigate the complexities of break fee calculations, evaluate your options, and make informed decisions tailored to your specific circumstances.
Please fee free to reach out to us if you need a hand navigating the complexities of break fees, so we can help to find the best solution for your situation. Simply pick up the phone and call 0800 LENDER (536337) or email to [email protected] and we will be delighted to be your Mortgage Adviser of choice.
