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Early repayment fee: the sting in the tail when paying off a home loan
Also called an early repayment adjustment, this fee can cost thousands when you end a home loan early.
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When you pay your home loan off early due to refinancing or selling a property, you may be breaking a contract with your bank. An early repayment fee could apply – learn how much it could cost and how to avoid paying it.
What fees are payable when I repay my home loan early?
Early repayment fees on variable rate home loans were phased out as part of government reforms a decade ago. Any variable rate loans entered into after 1 July 2011 won't come with early repayment fees, however fixed rate loans and variable rate home loans entered into before this time will attract fees. These may include:
- 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 fixed rate home loan off early. 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. Now, they generally only apply on fixed rate home loans. These break costs are usually charged when you leave your home loan before the fixed rate term ends. The exact fee depends on the loan amount, time remaining on your loan contract and current interest rates, but as a guide, it can be anything from a few hundred dollars to tens of thousands of dollars.
Further info about managing your home loan:
When can you be charged early termination fees?
You switch 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 that 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.
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.
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.
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