Could you save money by breaking your fixed term home loan?

Over the past few months, banks have been entering “mortgage wars”, with banks cutting many of their fixed term rates. In fact, as at 22 March, five New Zealand banks were offering two-year fixed home loan rates below 4%!

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As an example, here’s how the market has shifted over the past six months with two-year fixed home loans:

While not always the case, mortgage rates are often closely tied to the Reserve Bank of New Zealand (RBNZ’s) Official Cash Rate (OCR). So, when the OCR goes down, mortgage rates often follow.

The OCR has remained unchanged at the record-low 1.75%, since November 2016, and similarly, mortgage rates are currently low when compared to previous mortgage rates. In addition to this, RBNZ has indicated that the next OCR movement is likely to be downward, which could also mean mortgage rates coming down even further in the near future.

So, with RBNZ’s outlook – and many mortgage rates already coming down – you may be seriously thinking about switching home loans.

To help you decide whether breaking a home loan contract could pay off, Canstar weighs up the potential costs of breaking a two-year fixed term against any possible savings of switching to a lower rate.

What is a break fee?

A break fee is a fee charged when you break your home loan contract with a provider during a set period or fixed term.

Signing to a fixed home loan is essentially a legal contract between you and your home loan provider. The home loan provider is agreeing to keep the interest rate the same for a certain time period, and you are agreeing to make monthly repayments for the duration of the fixed rate period. If you repay your home loan sooner or decide to end the fixed term, that breaks the terms of the contract.

The break fee is a way for the home loan provider to recover the financial loss that the lender will incur from your decision to break the agreement. Lender’s obtain funds from a number of sources, including domestic deposit and international money markets, usually at a fixed rate. As such, it needs to recoup enough money from you as the borrower to be able to meet its own repayment obligations. Legally, providers cannot make a profit from the “break fee”, only recoup the losses.

What could it cost to break a fixed term loan?

We can’t give you an exact break free calculation – the break fee needs to be calculated on the day, based on the wholesale swap rate, the date you started the fixed term and the date you are breaking the contract. But we can give you an indication of what you might expect to pay.
As an example, we’ll look at a hypothetical scenario of a homeowner who entered a two-year fixed term home loan contract for $400,000 on 1 October 2018, at the average rate at the time (4.52%). Six months later, on 1 April 2019, the homeowner has seen the minimum rate for a two-year term is at a much lower 3.99%, and wants to switch. 

Looking at savings alone, the homeowner would save $3141.54 in interest for the remaining 18 months of the term, by moving to this lower rate. However, once you take into account break fees – which calculators available in the market show to be about $1800, it doesn’t look quite as attractive. There would be a net saving of around $1341.54 after subtracting the break fee. Depending on the provider, you may also have to pay other administration costs. 

Say this same homeowner – who signed up to a two-year fixed term at 4.52% on 1 October 2018 – wants to switch to the average rate as at 1 April 2019 (4.37%). Looking at savings alone, you would save $878.94 by making the switch. But, once you subtract the break fee of around $1800, then you’re actually worse off – and would lose around $921.06.  These examples are only indicative – as the break fee needs to be calculated on the day the contract is broken – but it shows you an example of what you could potentially pay to break a home loan contract.

The amount you could potentially save or lose by switching home loans depends on multiple factors – the home loan rate you are currently on, the rate you are switching to, the length of your home loan term, how long you have left of the term and how the provider calculates its break fee.

Regardless of the amount you could save or lose by breaking your fixed rate home loan, Canstar advices you to always try negotiate with home loan providers. In the current competitive market, home loan providers are more open to negotiation in order to keep existing customers and bring in new customers. Therefore, enquiring with home loan providers about a better deal, could actually mean you save money by breaking your fixed rate home loan, or gain even further savings.

Canstar is not in a position to advise you whether to break a term or not, but the above calculations can assist in understanding the factors you will need to consider when weighing up your options.

Should you switch home loans?

Given that the savings or losses of switching home loans depends on your personal circumstances, Canstar cannot tell you whether you’re better off switching home loans, or sticking it out for the full length of your fixed term period. This is a decision you will have to make after carefully doing all the sums. And, remember, once you’ve calculated your sums, try negotiate a better deal with home loan providers because this could also impact whether it will be worth breaking your fixed term home loan.

In addition to this, even if you could save money by switching, you should weigh up whether it is enough to warrant the process of going through the switch. Before making any decisions about switching home loans, it is vital that you check your home loan contract carefully.

You can also use Canstar’s home loan repayment calculators, to figure out what your repayments would be, based on different home loan interest rates.

Canstar’s home loans comparison tool also helps you compare what home loan interest rates are currently available, based on home loan type.

For the 2019 home loans ratings, Canstar researched and rated 58 home loan products from 10 providers in New Zealand. Take a look and find out which home loans could offer you outstanding value.

Read Canstar’s full home loans report