Beware break fee for fixed loans

Mortgage interest rates have fallen rapidly in recent months after the Reserve Bank began cutting the official cash rate in June. Home-owners can now lock in a mortgage for as low as 4.35% for a year if they meet special conditions.

According to interest.co.nz, this time last year the average one year fixed term mortgage rate was 6.04% across the banks.

This fall has prompted many mortgage holders to want to break their fixed term agreements to shift to a better rate.

Many banks enable customers to make small additional home loan repayments without penalty. However, lenders may charge an early repayment cost (ERC) fee or “break fee” if you repay a fixed interest rate loan or make a significant lump sum payment before the fixed rate term ends.

The reason lenders charge a break fee is because when a fixed rate loan is repaid early the lender may lose money. The fee recovers this loss. The loss occurs for the lender when interest rates at the time of early repayment are LOWER than the interest rate applicable to the loan. This is because the lender cannot re-lend the repaid funds at the same rate that it could when it first loaned the money.

If interest rates have risen or remained stable, there will not be a cost to the lender if the loan is repaid early, so a break fee will not be charged (though a separate administrative fee may be charged).

Calculating a break fee is a complex formula and the formulas vary across the banks. In times of falling interest rates, break fees can rise significantly. Mortgage holders can be surprised at the size of the fee if they repay their loan early.

If you have a problem relating to the break fee charged by your lender, you may contact the office of the Banking Ombudsman at bankomb.org.nz.

Bear in mind, simply charging a break fee is not necessarily an issue in itself. The types of things that could be a concern are:

• if your lender didn’t tell you about the break fee;
• your lender didn’t tell you about how the break fee is calculated;
• there is a mistake in the calculation; or
• your lender gave you incorrect advice about
• the most appropriate type of loan for your circumstances.

For a useful guide to Early Repayment Costs on Fixed Rate Loans click here