Fixed Rates - Break Costs Explained.....
Fixed Rates – Break Costs Explained…
Break costs are commonly regarded as one of the most complicated calculations to try and make is when you want to get out of your current fixed rate home, especially if the current interest rate on your home loan is in the mid 4’s and the market is telling you to switch to a lower cost option. Being hit with actual break costs that you thought may be involved yet not being prepared for exactly how much can come as a nasty surprise. And in the long run, you may or may not be saving all that much in terms of interest for the effort of switching. Each case is individual and many factors come into play. Let’s try and explain how it works.
Imagine you have just refinanced your home loan and made the decision to hedge your bets by fixing this new loan for 5 years as the fixed rate offer seemed pretty good at the time and all market indications pointed to rates not getting any cheaper according to expert opinions. You split your home loan as follows; $400k fixed for 5 yrs at 4.59% and $60k variable at 4.69% (the current rate at the time)
Fast forward 3 years and current variable rates on offer are in the mid-low 3% range, so you need to make a call - refinance the entire loan to a lower cost option or stay as you are?
Calculating the Costs:
If we use the above example, and keeping in mind that every lender calculates break costs in their own individual way….
a) Take the current balance of say $392k x the interest rate fixed at 4.59% = $17,993 interest per year or around $1499 per month,
b) Then take the current fixed rate offer by the lender for the same term (5 years in this example 3.59%) x the loan balance by the rate to get to a monthly interest cost figure = $1173 per month. The difference is a $326pm variance.
c) Multiply this by the remaining term of the loan of 26 months, and this will give you an approximate break cost fee less administration charges.
So, if you had 26 months left on the fixed component and you were to break, then your break costs could be around $8,476 plus administration fees in this example.
d) Then you need to calculate if the new loan will save you sufficient funds to warrant the switch. With the above case, if you moved to a variable rate of say 3.3%, the interest cost on the balance would be around $1078 pm x by 26 months (remaining fixed term).
e) Deduct this amount off what the interest cost would have been if you stayed where you were and the result should determine if it is worth breaking or not.
In this example, the saving over 26 months would be around $10,956, less the break costs of approx. $8,500 so actual savings are around $1,600 total over the next 26 months.
Confused? Call an experienced broker to assist rather than suffer in silence!
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Peter Vinci - 0438 041 111