Early Repayment Penalties & Break Costs Explained

Break costs are the fees charged when you exit a fixed rate home loan before the fixed period ends. They can be trivially small or devastatingly large — and the size is impossible to predict at the time you fix your rate. Here is how they work and why they can catch borrowers off guard.

Why Break Costs Exist

When you take out a fixed rate loan, the lender funds that loan by borrowing in the wholesale money market at a corresponding term and rate. If you break the fixed term early, the lender is left holding wholesale funding at the original rate but no longer has your loan earning the fixed rate against it. If wholesale rates have fallen since you fixed, the lender must now relend those funds at a lower rate — incurring a loss. Break costs recover that loss.

How Break Costs Are Calculated

There is no standard break cost formula across all Australian lenders, but the general calculation involves:

1. The original fixed interest rate at the time you fixed
2. The lender's current wholesale funding rate for the remaining term
3. The outstanding loan balance
4. The remaining months of the fixed term

The approximate formula used by most lenders is:
Break cost = (original wholesale rate − current wholesale rate) × loan balance × (months remaining / 12)

If the original wholesale rate was 4.5% and the current rate is 3.5%, the break cost on a $500,000 balance with 24 months remaining would be approximately: (0.045 − 0.035) × $500,000 × 2 = $10,000.

When Break Costs Apply

Break costs apply when you:

• Refinance a fixed rate loan to a new lender or to a different product before the fixed term ends
• Sell the property and repay the loan during the fixed period
• Make extra repayments that exceed the annual cap on fixed rate loans
• Switch from fixed to variable before the fixed term ends

When Break Costs Do NOT Apply

• When rates have risen (not fallen) since you fixed — in this case, the lender can relend at a higher rate and there is no economic loss, so break costs are $0 or near $0
• After the fixed period ends — no break costs from that point on
• On variable rate loans — variable loans do not have break costs (though they may have exit/discharge fees)

Estimating Your Break Cost Before Breaking

Before deciding to refinance out of a fixed rate loan, always request a break cost estimate from your lender. They are required to provide this. Compare the break cost against the interest saving you would achieve by refinancing — calculate how many years it would take to recoup the break cost through rate savings (your break-even period). If the break-even is 3+ years, breaking early often makes little financial sense.

Minimising Break Cost Risk

• Only fix your rate if you are confident you will hold the loan for the full fixed term
• Consider a split loan — fix part and keep part variable. If you need to break, you only break the fixed portion, not the entire loan
• Avoid fixing when wholesale/swap rates are at cyclical lows — this is when break costs will be largest if rates subsequently fall further
• Check your lender's extra repayment cap before making additional payments on a fixed loan

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