Getting rid of a fixed-rate home loan: Is this possible?
Fixing your home loan over a certain period gives you a level of certainty from the future interest rate movement. It also offers you peace of mind as your monthly repayment on a home loan is fixed no matter what happens during that period. However, things do not always go the way we want. When interest rates move faster and current rates are much lower than what you have fixed your rate at, the same decision for the fixed-rate arrangement starts becoming a bit of a burden.
Why have rates moved so fast?
It’s due to the Coronavirus or COVID-19 health crisis. COVID-19 is a global health pandemic and governments all around the world are trying their best to restrain the spread of the virus. Isolation, Social Distancing and Flattening the Curve have become the most popular buzzword these days. While the governments are desperately trying to reduce the spread of coronavirus, the measures are taking a toll on economic activities as well. Many governments are battling at two fronts: health crisis and potential economic downturn. Following government announcement of several economic stimuli to get to the other side of the economic cycle, Australian banks have also come up with few relief packages for homeowners who may have difficulty in making loan repayment, during these difficult times of coronavirus crisis.
One of the several relief measures is; the banks lowering their fixed rate, offering a record low.
If you have your home loans at a variable rate, then you can apply for a fixed-rate loan without any issues. However, if you have fixed your rate already at a much higher rate and you still got a few months or even years to go in that agreement, then you need to tread this situation very carefully.
Can you break your current fixed rate agreement?
Yes, you can break the fixed rate prior to the expiry of your agreed fixed term. However, banks charge you a breaking cost (or early payment fee or whatever term they call it) for taking this action. This will be a one-off fee and can be up to thousands of dollars.
Why do banks charge breaking costs?
When you fix your home loan, banks also put an arrangement in place to borrow money from their wholesale funding that matches your fixed term, for the same period on the same day. The lenders do this to minimize the risk in their funding arrangements.
When you want to break the arrangement earlier than the agreed date, the bank cannot do the same with the other party (funding provider). The bank will have to continue its payment over the remaining period. When the lender makes a loss, as a result, you will be charged the breaking cost.
How much would be the breaking cost?
Your bank calculates the breaking cost based on three broad factors: your home loan balance, remaining time frame on your fixed term agreement, swap rate differential. The difference in swap rate (the interest rate applicable when banks and businesses lend to each other) is measured as the changes in the wholesale money market from the date you fixed your home loan to the date you are breaking your home loan.
The swap rate changes every day and as a result, the breaking cost estimation given by your bank is valid for certain days only.
For example, if you have fixed your home loan of $400,000 at 3.79% pa for 2 years and there is one year remaining on your fixed agreement while you want to break the agreement and the bank’s wholesale funding cost for the remaining one year as the rate moves to 2.79% pa then the breaking cost is calculated as:
Breaking cost = $400,000 x (3.79%-2.79%) x 1 = $4,000
Please note that the banks do not disclose their wholesale funding costs publicly and each lender might have their own funding costs.
How to know how much is your breaking cost?
For privacy reasons, banks generally do not disclose this information to your mortgage. You need to contact the mortgage servicing unit of your bank directly and find out this breaking cost yourself. Please be mindful that the bank phone lines may tend to be busier these days as they go through a huge influx of calls from financially distressed households to defer their loan repayment. Please show your patience and call them sometime later if you are not successful in your first attempt.
If your fixed rate is significantly higher than the current fixed rate offered in the market, what can you do?
Since we are going through an unprecedented time in history and things are moving quickly, so are your interest rates as well. If you have fixed your home loans at much higher rates than what is being offered in today’s market, you need to consider re-adjusting. You might have the following options for yourself:
Option 1: Refinance to another lender
You can consider this option when you have enough income to service the new loan application and when the loan being refinanced is not more than 80% (70% in some areas, to some lenders) of the property value. If you refinance more than these cut off levels, you are required to pay lender mortgage insurance which could be thousands of dollars.
You can do the following:
- Call your lender and find out the breaking cost
- Call your mortgage broker and calculate how much you can save in interest by refinancing
- Ask your mortgage broker if there are any bank promotions available for refinancing campaign
- Ask your mortgage broker to initiate the refinance process to the appropriate lender
Option 2: Break current fixed rate and re-fix with the current lender
If you do not have enough income to refinance the loan application or your loan amount to the property value ratio is more than the required threshold, then you need to consider staying with the current lender. However, you can engage in re-negotiation as below:
- Call your lender and find out the breaking cost
- Calculate how much you are going to save in interest by changing to the new fixed rate
- If the saving in interest is higher than the cost, breaking the current arrangement and re-fixing can be the option for you
Please call your mortgage broker to arrange for this; The new fixed rate you get via the broker channel could be different from the rate you would get over the phone!
We have tried to make this article as much comprehensive as possible. However, we admit that the article still contains some financial jargon. If you struggled to understand the concept, you can always contact us or leave a callback request. Our mortgage brokers will always be there to assist you further.