Break Costs Explained: When Refinancing Makes Financial Sense

If you have a fixed rate home loan and want to refinance, sell your property, or pay off your loan early, you may face break costs. These charges can be substantial—sometimes tens of thousands of dollars. Understanding how they work and when refinancing still makes sense is crucial for making informed decisions.

What Are Break Costs?

Break costs (also called "break fees," "early repayment costs," or "economic costs") are charges that apply when you exit a fixed rate loan before the fixed period ends.

Why Do They Exist?

When you fix your interest rate, your lender locks in funding at a corresponding wholesale rate. If wholesale rates have fallen since then, the lender faces a loss when you exit early. Break costs compensate them for this loss.

Key Point: Break costs are not a "penalty" in the traditional sense—they're based on actual financial calculations related to funding costs.

How Break Costs Are Calculated

The Basic Formula

Break costs typically follow this logic:

Break Cost = (Your Fixed Rate - Current Wholesale Rate) × Loan Balance × Remaining Term

A Practical Example

Your Situation:

• Fixed rate: 6.50%
• Remaining fixed term: 2 years (24 months)
• Loan balance: $500,000

Market Conditions:

• Current wholesale rate for 2-year term: 5.50%
• Rate difference: 1.00%

Calculation: $500,000 × 1.00% × 2 years = $10,000 approximate break cost

Why "Approximate"?

Actual calculations are more complex:

• Daily interest calculations
• Present value adjustments
• Specific wholesale rate benchmarks
• Individual lender methodologies

Important: The calculation varies by lender, and the exact formula is often not publicly disclosed. Always request an estimate from your lender.

When Break Costs Apply

Scenarios That Trigger Break Costs

1. Refinancing to another lender
2. Selling your property
3. Paying off the loan in full (inheritance, windfall)
4. Switching to variable with current lender
5. Making extra repayments beyond allowable limits
6. Partial discharge (selling part of security)

Scenarios That May NOT Trigger Break Costs

1. Making allowable extra repayments (typically $10,000-$30,000/year)
2. Porting your loan to a new property (if lender allows)
3. Waiting until fixed period ends (obvious but important!)
4. Death of borrower (some lenders waive in this case)

The Break Cost Wild Card: Market Movements

When Break Costs Are High

Rates Have Fallen Since You Fixed:

• You locked in at 6.50%
• Current rates are 5.50%
• Lender loses 1.00% if you leave
• You pay substantial break cost

Longer Remaining Term:

• More time remaining = higher break cost
• Breaking with 3 years left costs more than 1 year

Larger Loan Balance:

• Higher balance = higher break cost
• $800,000 loan has proportionally higher costs than $300,000

When Break Costs Are Low or Zero

Rates Have Risen Since You Fixed:

• You locked in at 6.00%
• Current rates are 6.75%
• Lender actually benefits if you leave
• Break cost may be zero (they won't pay you though!)

Near End of Fixed Term:

• Only months remaining = minimal break cost
• Sometimes worth waiting

Small Loan Balance:

• Smaller loans = smaller absolute break costs
• May be worthwhile regardless

Getting Your Break Cost Estimate

How to Request

Contact your lender and ask for:

1. Current break cost estimate as of today's date
2. Indicative break cost if rates stay the same
3. Explanation of calculation methodology

What to Expect

• Response time: Usually 1-5 business days
• Validity: Estimate is only valid for that day
• Accuracy: Actual cost may differ at settlement
• Trend: If rates keep falling, costs may rise

Important Caveats

• Break costs change daily with market movements
• Estimates are not binding
• Actual cost calculated at discharge date
• Get fresh estimate close to decision time

The Break-Even Analysis: Should You Still Refinance?

The Framework

Compare: COST OF STAYING vs. COST OF SWITCHING

Cost of Staying (Current Loan)

Calculate total cost for remaining fixed term:

• Interest at current fixed rate
• Any ongoing fees
• Opportunity cost of lost features

Example:

• Remaining term: 2 years
• Loan: $500,000 at 6.50%
• Annual interest: ~$32,500
• Total 2-year cost: ~$65,000 interest

Cost of Switching

Calculate total cost including break fee:

• Break cost (one-time)
• New loan interest for same period
• New loan setup costs
• Any other fees

Example:

• Break cost: $10,000
• New loan: $500,000 at 5.50%
• 2-year interest: ~$55,000
• Setup costs: $500
• Total 2-year cost: ~$65,500

The Verdict

In this example:

• Stay: $65,000
• Switch: $65,500
• Difference: -$500 (switching costs more)

But wait—there are other factors to consider:

• New loan features (offset account)?
• Rate after fixed period ends?
• Ongoing fee differences?
• Flexibility benefits?

Extended Analysis

If You'd Stay in New Loan Beyond 2 Years:

Years 3-5 at new lower rate vs. reverting to old lender's variable:

• New lender variable: 6.00%
• Old lender revert rate: 6.80%
• 3 additional years of 0.80% savings = ~$12,000

Total 5-year comparison:

• Stay then revert: $65,000 + higher variable costs
• Switch now: $65,500 + lower ongoing costs
• Long-term winner: Switching

Real-World Decision Scenarios

Scenario 1: Small Break Cost, Big Rate Difference

Situation:

• Break cost: $3,000
• Current rate: 7.00%
• New rate available: 5.75%
• Loan: $400,000, 2 years remaining

Analysis:

• Monthly saving: ~$416
• Payback period: ~7 months
• 2-year net saving: ~$7,000

Decision: ✅ Refinance makes sense

Scenario 2: Large Break Cost, Small Rate Difference

Situation:

• Break cost: $15,000
• Current rate: 6.25%
• New rate available: 6.00%
• Loan: $600,000, 3 years remaining

Analysis:

• Annual saving: ~$1,500
• Payback period: 10 years
• 3-year net loss: ~$10,500

Decision: ❌ Wait for fixed period to end

Scenario 3: Selling Property

Situation:

• Break cost: $8,000
• Must sell due to divorce settlement
• No choice but to discharge

Analysis:

• Can't avoid break cost
• Factor into settlement negotiations
• Consider if partner should bear portion

Decision: 📋 Unavoidable, plan accordingly

Scenario 4: Rising Rates, Zero Break Cost

Situation:

• Break cost: $0 (rates have risen)
• Considering switch to capture lower fixed before rates rise more

Analysis:

• No financial penalty to switch
• May lock in better rate
• Compare new fixed vs. variable options

Decision: ✅ Good opportunity to review options

Strategies to Minimize Break Cost Impact

Strategy 1: Time Your Exit

If break costs are high but you can wait:

• Monitor remaining fixed term
• Break costs reduce as term shortens
• Calculate monthly reduction
• Time exit when cost-effective

Strategy 2: Negotiate Everything Else

If break costs are unavoidable:

• Negotiate maximum cashback from new lender
• Request fee waivers on new loan
• Ask new lender for contribution to switching costs
• Some lenders offer refinance rebates

Strategy 3: Port Your Loan

If moving house but staying with same lender:

• Loan portability may avoid break costs
• Transfer fixed rate to new property
• Subject to lender approval and policies
• Check conditions before assuming available

Strategy 4: Wait for Rate Rise

If rates are trending up:

• Break costs decrease as wholesale rates rise
• Monitor weekly rate movements
• May reach zero if rates rise enough
• Balance against missing lower new rates

Strategy 5: Partial Break

If you have split loan (fixed + variable):

• Only fixed portion has break costs
• Variable portion can refinance freely
• Consider refinancing variable only
• Reassess fixed portion when term ends

Break Costs and Life Events

Divorce and Separation

Considerations:

• Break costs are a shared liability
• Factor into property settlement
• May be necessary regardless of cost
• Get estimate early in process

Financial Hardship

Options:

• Discuss hardship provisions with lender
• Some lenders may waive or reduce
• Switch to interest-only (may trigger break cost)
• Seek financial counselling

Death of Borrower

Many Lenders:

• Waive break costs on death
• Check your loan contract
• Estate planning consideration
• May still apply in some cases

Questions to Ask Before Committing to Fixed

Before You Fix:

1. What are the break cost provisions?
2. How much can I repay extra per year?
3. Is loan portability available?
4. What's the revert rate after fixed period?
5. Can I split my loan to reduce risk?

Understanding Answers:

• Get break cost formula in writing if possible
• Understand your extra repayment limits
• Confirm portability conditions
• Compare revert rate to market
• Consider split for flexibility

The Bottom Line

Break costs can be significant, but they shouldn't automatically prevent refinancing. The key is doing thorough analysis:

1. Get an accurate break cost estimate from your current lender
2. Calculate total cost of staying vs. switching over relevant timeframe
3. Factor in long-term benefits beyond just the fixed period
4. Consider non-financial factors like features and flexibility
5. Make an informed decision based on complete picture

At Ding Financial, we specialize in comprehensive refinancing analysis. We'll calculate your true break-even point and help you understand whether refinancing makes sense in your specific situation.

Contact us for a detailed break cost assessment and refinancing recommendation.