Should you break a fixed-rate loan?

When should you break a fixed rate loan?

It’s a common question this week as loan holders react to an eventful few days in the banking industry.

The Reserve Bank decided last Tuesday to lower the cash rate to a record low of 1.5 per cent. Most mortgage holders were hoping the major banks would pass on the full cut of 0.25 per cent.

But that didn’t happen among the big four banks, who roughly cut their standard variable rates by about half of that rate.

If you took out a fixed rate loan about 12-18 months ago, you’re probably asking now whether it’s time to break that loan and sign up again.

Back then, you were probably very happy with something under five per cent.

That seemed like a good deal at the time and it was recommended for the many customers who knew that they could comfortably pay back a loan at that speed.

But the series of cuts since then has changed the landscape – and that’s when the break fees for fixed rate loans have to be compared to the advantages from a new deal.

Let’s look at two examples:

• A person has a fixed loan of $325,000 at a rate of 4.94 per cent – with 15 months remaining on the loan period. They can access rates between 3.79 per cent and 3.59 per cent, with a break fee of $4,400 and minor government costs. Is it worth it? Not this time because the difference will work out almost even.
• A person has a fixed loan of $1.1 million at a rate of 4.79 per cent – with 51 months remaining on the contract. The break fee is substantial – $22,500 – to access new rates of 4.04 per cent. But this one is worth it. The benefit to the loan holder will be about $16,000 over the course of the loan. It’s time to change.

Each client is different so there’s no single rule.

But, if you can make a new fixed loan work in your favour, it may be time to think about breaking.

Petrol prices are an example of regularly shopping for the best deal: would you drive an extra 500m to get petrol 20c per litre cheaper?

The second most common question we’ve got this week is: how can the banks not pass on the full rate?

That shouldn’t come as a surprise because it comes down to a simple equation – the bank sells money.

Has the cost of selling that money increased? There’s no doubt that it has.

Therefore, the banks were unlikely to pass on the full cut but that brings about its own views, particularly from politicians.

It’s not the last we’ll hear about that decision, especially if there are more cuts in the future.