To Break, or Not to Break…
That is the question!
As interest rates show signs of easing, many Kiwi homeowners may be contemplating breaking their fixed rate to secure a new, lower one. But would breaking really be advantageous for you? Let’s take a deep dive into mortgage break fees, and how to calculate if breaking would be worth it…
WHY YOU MIGHT CONSIDER BREAKING A FIXED RATE
There are several reasons why breaking a fixed rate might be necessary, including:
Debt Consolidation: Refinancing to combine other high-interest debts into one lower-rate mortgage.
Selling the Property: Relocation or lifestyle changes may require selling, which means breaking the fixed rate.
Accessing Equity: Refinancing your mortgage to tap into your home’s equity for renovations, investments, or other financial needs.
Of course, one of the most common reasons to break a fixed rate is to secure a lower interest rate. A reduced mortgage interest rate can save you money over the new term and give you some immediate relief in terms of your monthly budget or cash flow.
If you're considering breaking your fixed rate to take advantage of a lower one, the next step is understanding how to calculate the potential benefit...
BREAK FEES: WHAT ARE THEY AND HOW ARE THEY CALCULATED?
When you lock in a fixed mortgage rate you're entering into an agreement with the bank, which secures funding at wholesale rates to lend to you. If you break your mortgage agreement early, the bank may incur a loss – due to the difference between the wholesale rate they ‘purchased’ your funding at and the current wholesale market rate. A break fee helps the bank recoup that loss.
In New Zealand, break fees are calculated based on wholesale or swap rates, which reflect the cost to the bank of lending at the fixed rate for the remaining term. (Swap rates are not the same as the interest rate you pay on your mortgage, they are the wholesale rate that banks add a margin to, in order to make a profit.)
To find historical and current swap rates, visit Interest.co.nz.
CALCULATING BREAK FEES – A WORKING EXAMPLE
You can calculate a rough estimate of your break fee yourself with a bit of simple math. Let’s use an example to illustrate: let’s say that exactly one year ago today, you took out a mortgage of $500,000. You fixed your rate for five years, but now you’re wanting to refinance – four years early.
Loan Amount: $500,000
Original Fixed Term: 5 years
Time Elapsed: 1 year
Remaining Fixed Term: 4 years
Step 1:
Look up what the 5-Year swap rate was at the time of fixing (the day you fixed your mortgage).
In our example: 5.18%
Step 2:
Find the current (‘as at today’) swap rate for the remaining term. In our example, we need to find today’s swap rate for a four-year fixed term – as this is the time remaining in the original five-year fixed term.
In our example: 3.94%
Step 3:
Calculate the difference between the 5-Year Swap Rate (5.18) and the 4-Year Swap Rate (3.94).
In our example: 5.18% - 3.94% = 1.24%
Step 4:
Multiply your mortgage amount by the difference in the two rates.
In our example: $500,000 x 1.24% = $6,200
Step 5:
Finally - to arrive at the estimated break fee - multiply your figure above by the fixed term remaining (4 years).
In our example: $6200 x 4 = $24,800 break fee
Note: this is a rough estimate and you should consult your lender for an exact figure.
ADDITIONAL COSTS
If you’re breaking your contract with the bank to move to another bank entirely, there is likely to be other costs on top of the break fee.
If you’ve had your mortgage with the bank less than three years, you’ll need to pay back part or all of any cash contribution the bank gifted you when you took out the loan. Moving your mortgage to another lender will also require legal documentation, so be sure to add legal fees into your total ‘break cost’
These additional costs may be mitigated by a cash contribution offered to you by the new lender – they may even cancel each other out.
OK, THOSE ARE THE COST(S) – WHAT ARE THE SAVINGS?
To calculate how much you could save on your mortgage by breaking your fixed rate and securing a lower rate, let’s continue with the same working example. We’ll assume the $500,000 loan was fixed for five years at 5.99% a year ago, and we’ll compare that to a four-year fixed rate of 5.59% today.
Original Repayments at 5.99%
Loan Term: 30 years
Monthly Repayment: $2,987
New Repayments at 5.59%
Remaining Loan Term: 29 years
Monthly Repayment: $2,911
Monthly Savings:
$2,987 - $2,911 = A saving of $76
Meaning, in our example, there would be a saving of $76 per month if switching from a fixed rate of 5.99% to 5.59%
Total Savings
On an annual basis, the saving is $76 x 12 = $912
And, over the four years that you re-fixed at the new lower rate, that’s a saving of $912 x 4 = $3648
Net Result
So, after we factor in the Break Fee, what are the actual net savings here?
$3,648 - $24,800 = -$21,152
That’s right - in this scenario, breaking the fixed rate could actually result in a net loss of over $20,000 over the remaining 4-year term.
Since most homeowners would need to add the break fee to their loan principal, any savings from a lower rate would be far outweighed by the extra interest charged on the increased balance!
ADDITIONAL COSTS + RISKS OF BREAKING
Uncertainty of Future Interest Rates:
Predicting future interest rate movements is challenging. Rates may not decrease as anticipated, potentially diminishing the benefits of breaking your fixed rate.
Opportunity Cost:
Funds used to pay the break fee could have been otherwise allocated to an investment, paying down other higher-interest debt, etc.
Here’s an example - following on from our scenario above - of opportunity cost in action: Let’s say you use your monthly savings of $76 from your lower repayments to invest in New Zealand shares, which have a 15-year average annual return of 7.9%.
Over four years, the future value of these investments would be approximately $4,274
In this scenario, this investment would not generate sufficient returns to offset the cost of the break fee ($24,800) within the 4-year period.
In comparison, investing your break fee would, in four years, turn your $24,800 into approx. $33,615.
This is an illustrative example only and assumes a consistent annual return of 7.9%, based on the 15-year historical average for New Zealand shares. Shares are a risky investment designed for long-term holding, and returns are not guaranteed. You should always consult a financial advisor before making any investment decisions.
WHAT ARE THE BENEFITS TO BREAKING?
Despite all we’ve outlined above, there may still be some pluses to breaking your fixed rate early, including:
Lower Monthly Repayments:
If it’s immediate cashflow relief you’re after, re-financing to a lower interest rate can certainly reduce your monthly mortgage repayments.
Anticipated Decline in Interest Rates:
If interest rates are expected to continue to fall, breaking now could enable you to secure an even lower rate in the near future. For example, you could fix for just one year (at 5.59 in our example) and when that expires, the rates may have dropped even further.
Flexibility for Future Financial Decisions:
Breaking a fixed rate can provide the flexibility to adjust your mortgage structure to better align with your financial goals.
OUR FINAL THOUGHTS
Breaking a fixed rate is a big decision that takes careful thought - balancing costs, potential savings, and your own personal financial situation. If you’re considering it, start by calculating an estimated break fee (or ask your bank for an exact figure) and then calculate your possible savings to get a clear picture of the pros and cons.
While the prospect of lower monthly mortgage repayments is appealing, the associated break fees and uncertainties must be carefully weighed.
An independent mortgage broker like WealthHealth can help you navigate the numbers and offer advice that’s tailored to you - empowering you to make the best choice for your family, your finances, and your future.
Our blog is not intended to be taken as personal advice and is for informational purposes only.
Before acting on this information, contact our mortgage broker to ensure it is suitable for your circumstances.