Break fees: is it worth paying?

If you fixed your mortgage in the middle of last year, you may be gritting your teeth as banks roll out lower interest rate specials.

Two-year fixed rates hovered around 6.5 per cent this time last year, compared to anything from 4.65 per cent now.But breaking a fixed-term mortgage comes with a cost. Whether it makes sense to take the plunge depends on whether the fee the bank will charge you is less than the repayment savings you stand to make from a cheaper interest rate. The way banks calculate break fees is a complicated process.

An extremely simplified version is this: the bank looks at the interest rate you are committed to, the amount of your loan and the term you have left to run.

Then it looks at what it could charge someone else for that same amount of money.

If you have $500,000 fixed for another year at 6.5 per cent, the bank will consider that the most it could get for the same chunk of money lent to someone else for the next year is about 5 per cent. So it might ask to be compensated for the difference of 150 basis points, or about $7500 for the year.

The key then is to refix at a much better rate so that the interest savings make the break fee worthwhile.

The difference in repayments between a $500,000 loan at 6.5 per cent and a loan at the current cheapest two-year rate of 4.65 per cent is about $895 a fortnight so you would save the cost of the break fee in 10 months.

Banks also apply administration fees. The break fee can vary day by day.

David Boyle, group manager of investor education at the Commission for Financial Capability, said doing the sums could be a worthwhile exercise for a lot of borrowers.

‘‘It is a pretty competitive market at the moment. If there is a 1 per cent or 2 per cent difference [in interest rates] you could find you pay off the break fee within three or six months. It can make such a material difference.’’

He said banks would not broach the conversation about breaking a rate, but a borrower could seek help from a mortgage adviser to review their circumstances.

Broker Glen McLeod, of Edge Mortgages, said he had seen a big increase in the number of people inquiring about breaking their loans. He said in most cases people would not avoid paying the interest they had signed up for on a fixed rate, but the move could make a difference to cash flow.

‘‘If the break cost is $1000 and you have 12 months to run on your loan and payments come down by $80 a month, that only saves you $960 and all you are doing is prepaying the interest. Banks never lose on it.’’ McLeod said the answer sometimes lay with asking another bank to stump up a cash contribution to cover the break fee.

Many of the banks offer tempters of a couple of thousand dollars to people who switch their loans. McLeod said many of the banks also had teams of people working to keep customers, so someone who threatened to leave might be able to negotiate a better deal from their own bank.

‘‘It’s a fine line the banks are playing because if they set a precedent and start paying break costs for customers it ends up with what’s the point in having fixed rates in the first place?’’

He said he dealt with one customer this week who was faced with a $6000 break fee. Another bank offered $4000 to move, but the customer had to pay legal fees as well. They were fixed in the late 5 per cent interest rate range and were looking at moving to 4.35 per cent. ‘‘The difference is quite large but you have got to balance it out.’’

Massey University banking expert Claire Matthews said there was no right answer. ‘‘It comes down to individual circumstances, what rate they are on and what they are going to.’’