Careful planning before you take out your home loan can help you avoid any early repayments fees in the future.
Early repayment fees for variable rate home loans were phased out as part of government reforms. But while new variable rate loans entered into after 1 July 2011 won't come with early repayment fees, fixed rate loans and variable rate home loans entered into before this time will. Read on to learn more about how you can avoid these fees.
Comparison of fixed rate home loans that allow extra repayments
What fees are payable when I repay my home loan early?
- Exit Fees. Exit fees can go by different names, including discharge fees and are charged on both variable and fixed home loans when your loan is closed. These can range from $150 - $350.
- Early termination fees. Early termination fees also go by different names depending on your lender, but they are all costs you will be responsible for if you pay your variable rate or fixed rate home loan off early. As mentioned above, these fees were regularly charged on variable rate home loans prior to the 1 July 2011 ban if you left the loan within three to five years of opening it. In terms of fixed rate home loans, break costs are still usually charged when you leave your home loan before the fixed rate term ends. Although exit fees are now banned on variable rate home loans, if you entered into a loan a short time before the ban was introduced, you might still be required to pay these fees, as some lenders will charge them if you try to leave within three to five years.
When can you be charged early termination fees?
Switching home loans
One of the most common reasons people are charged early termination fees is when they move their loan to a new bank. Usually the switch is done to take advantage of lower interest rates. You must be careful to make sure that your savings in interest is enough to cover the early termination fees that you will be charged in this situation. You can use our switching costs calculator to help work out the savings from moving from one loan to another.
Your wages increase
Getting a big promotion or raise is another reason for early repayment of a loan. You may be able to make higher payments which pays down the debt early, saving on overall interest. Again, you have to do all of the calculations to make sure the savings are worth the added cost of early termination fees. It may be smarter to invest the extra money instead of paying the loan off sooner depending on the amount your bank charges in fees.
You come into a large sum of money
Maybe you received an inheritance or come across a lump sum of money which you use to pay out your loan. You will save money on interest, but ensure that the savings balances out the cost of your fees.
You sell your business
Again, coming into money from the sale of a business may allow you to pay off your loan early. This situation is unique because while you will be charged early termination fees you could save on interest and perhaps on taxes because you have reinvested the money you profited from the sale. This requires you to do the math, possibly with the help of an accountant to make sure you are saving money in the long term.
You are able to borrow money from your partner or relative
If you borrow money interest free to pay off your loan early, all you have to do is make sure the savings offsets the interest. But, if the money you borrow has to be paid back with interest you have to consider that cost when you choose to do an early termination of your loan.
You make extra payments
If you consistently make extra payments on your loan whenever you have extra cash your loan will be paid off early. These extra payments affect your bottom line in a positive way, but if they allow you to pay your loan off before the five year mark you will also be charged early termination fees.
Fixed rate break costs vs early repayment fees
These fees are only charged on fixed rate loans. They are the amount you will owe the bank if you pay your loan before the term ends. These fees are calculated by comparing the interest rate you locked your loan in at and the current market rate. Then the length of time that is left on the loan is compared to the initial amount that was borrowed.
For example, you have a loan of $200,000 at a rate of 6% for five years and decide to sell the property and then pay off the full amount. If interest rates drop 2% you would take the loan amount multiplied by the time left on your term multiplied by the change in the interest rate.
Fee = $200,000 x 2 years x 2% (change in loan rate) = $800
Other fees can vary and might include discharge fees. These are on top of the previously mentioned charges.
Early termination fees are charged when the bank has costs they need to cover due to you paying your loan out early. The bank has also borrowed money in order to provide your loan. When you pay early they lose out on the interest they expected, a portion of which would have gone to the payment of their loan. This is why they charge early termination fees. The amount of these fees depends on the amount of time you have left on your loan.
How to avoid early termination fees on your home loan
As mentioned above, it's difficult to avoid a fixed rate break fee - these are usually calculated to make sure your lender won't lose out on you leaving your loan early - but the good news is that after the exit fee ban in 2011 you're more likely to receive a waiver or fee reduction when leaving a variable rate home loan which still has an early repayment fee.
Information on the banking reform website states that lenders are more likely to waive these early repayment fees in the "spirit of competition". Even if your lender doesn't initially waive these fees, it's a great idea to ask, as you might be able to use your loyalty and cite the ban to get out of paying the fee.
Tips to avoid early repayment fees
- If you think you are going to own your property for only a short period of time you should investigate other options that may charge a higher interest rate, but cost less or nothing in early termination fees.
- Be careful when using a mortgage broker. Some non-banks charge up to 1.5% in early termination fees if they rely on brokers. This adds up to three times your monthly repayment. Instead calculate the cost of switching yourself and present it to your lender. Then request that they waive fees or give you a lower rate because you saved them money by avoiding a broker.
- Ask your lender if they will work with your current loan instead of switching. They may be willing to waive fees or even reduce your interest rate in order to maintain your business.
- Shop around before speaking with your bank. Chances are if you are well informed you can actually make a stand and demand your fees be waived if you were to bank with them for your loan. Many lenders will want to work with you to keep you as their customer.
- The biggest part of avoiding exit fees on a home loan is to know your products and be absolutely clear where you stand if you sign on the dotted line.
Switching home loans
The purpose of switching your home loan is to get lower rates or added features on your mortgage. Once you have purchased a home you should always be on the lookout for better rates, because the savings can be quite significant if you can find better deals. Interest rates constantly change, so what you thought was a great rate when you first took out your loan may be higher than what the current market, at any given time allows. The process of switching your home loan is fairly simple. You research and find the rates and terms that you want. Be sure to calculate what your current home loan costs and the features it offers and compare it to the same calculations on a new loan. Then communicate with several different lenders, including the one who holds your current loan, to find the best deal.
How to repay your home loan sooner
Paying off your home loan faster than planned will save you money in interest, not to mention freeing up the cash that would have gone to your monthly payments. Since most people do not just come into thousands of extra dollars all of a sudden you have to find ways to fit early repayments into your budget. Luckily, there are ways to do this that are easy to do even when your income does not change.
- Have your salary direct credited. Ask your lender how to have your salary direct credited. This will reduce your loan amount considerable over time. You can use a credit card to pay your other expenses and then have the payment direct debited from the loan account.
- Make payments fortnightly. By doing this instead of only paying monthly you will make an extra payment each year (there are 26 fortnights in a year, meaning you in effect make 13 monthly repayments instead of the regular 12), saving thousands of dollars by the time your loan is paid off.
- Pay more than the minimum. This is an easy pay off more of your home loan, just pay a few extra dollars each month when you make a repayment. You will be surprised at how quickly it adds up.
If you are planning to switch your loan you will have to make sure that the cost of switching, including fees, is worth the amount you are saving by switching or paying your loan early. In addition there will also be start up fees that can consist of application and set up fees. These fees alone can reach the $2000 mark, so be sure to include them in your switching budget.