By Effie Zahos,
, July 2009
Homeowners who fixed their rate back in 2007 are paying around $650 a month more on a $300,000 mortgage and probably still have another year of being locked in.
Chances are these homeowners have already been dealt the harsh reality that if they break their expensive fixed-rate loan in favour of another, cheaper fixed rate, they’d be no better – if not worse off.
Not too many homeowners are aware of how ridiculously expensive break costs are until they need to get out of their contract.
On a $300,000 mortgage at a fixed 9 percent pa with one year left to run you’d be up for over $10,000 in break cost fees. Sure, you’d save around $7800 in the first year by just refinancing to the current variable rate of around 5.7 percent.
You just need to make sure that variable rates don’t go up in the next year in order to recoup the rest of the $2000 odd shortfall.
As you can see it’s never too clear whether or not you should lock in, pay break costs or just stick to variable interest rates when it comes to home loans.
Why are break costs fees so high and why can’t they be waived? These are two questions Money is often asked. First up, it’s important to understand that home loans attract three different types of exit fees.
Early termination fees typically apply if you refinance or repay your loan within the first five years. This fee is generally attached to loans that offer a cheap ongoing rate or a special honeymoon rate. Expect to pay around three months interest on the outstanding balance as the early termination fee. Discharge, administration and other fees associated with closing your loan are also payable, but thankfully nominal.
The break costs, only applicable for fixed-rate loans, are the real killer.
Break costs go up as interest rates come down. That’s because break costs represent the difference between the total interest you agreed to pay for the fixed term of the loan and the current interest rate.
So going back to our example, if your original fixed rate was 9 percent for three years and you wished to refinance or repay the loan with one year left to run, the lender would need to charge you the difference between 9 percent (the rate you agreed to pay) and 5.7 percent (the current variable rate at what they could on lend).
The difference between these two rates and the size of the loan determines how many thousands you’d be up for. And as for waiving the fee the answer is fairly logical: banks would lose out as they couldn’t re-lend the money at the same high rate – especially as variable rates are so low now.
Having said that, if on the other hand the current standard variable rate was higher than the 9% fixed rate that you locked in and for whatever reason you had to break your contract (let’s say you won lotto) the bank would pay you the difference. Now that’s a fresh change and one I’m yet to see.
So is now a good time to lock in? As Money reported in last month’s issue the window of opportunity to lock in a good fixed rate is fast disappearing. June saw the Reserve Bank of Australia once again pause on rates – preferring to keep the cash rate at a steady 3 percent for the past two months.
Right now very few borrowers are locking in, preferring to ride the low variable rates. History shows that borrowers tend to wait until economic recovery is confirmed and by then it will be too late.
Visit www.ratecity.com.au for the latest fixed rates. At the time of writing Rams and ING Direct were both offering three- year fixed-rate loans at 5.89 percent. If you’re with a major bank chances are you may have to pay a premium for locking with your existing lender as fixed rates have risen.
The good news with home loans though is that most will allow you to split your lending across fixed and variable rates. Many fixed loans even accept additional repayments of up to $20,000 a year.
Money Magazine's July 2009 issue is out now. Subscribe now.
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