To break or not to break, that is the question

With interest rates at an all-time low, a lot of people are thinking about breaking their current fixed rate to reset at something lower. This is effectively breaking the contract you have signed with the bank, the benefit on the face of it appears obvious for the borrower, stop paying an old fixed rate above 4.00% and start paying a new rate of perhaps 2.79%. But when the bank loaned you money fixed at 4.50% for three years say, they borrowed money from the money markets for a fixed term of three years at a rate which was probably close to 3.30% (the difference being their margin, which is how they make money). The bank cannot go along to the money markets and give this money back, they can only lend it back out at whatever the current rate is for the remainder of your fixed term.

So, if you want to break your contract the bank will calculate a cost which you must pay, called the “break cost” and it will represent the difference between what their old rate was and how much they can currently lend this money back out for, for the remainder of your current fixed term. The bank will calculate this cost which leaves them in the same position as if you had not broken your rate. This cost can be high and in most instances not worth paying.  Generally the saving is offset by the cost, leaving you back at square one.

The only real upside is that in today's environment you could lock in these low rates for a 3–5 year term and guarantee you a rate under 3.00% for quite some time. However, with interest rates predicted to remain low for at least the next 12 months, it is likely that when your current fixed interest rate expires you will be able to lock in at a very low interest rate (maybe even lower than what they are today).

In summary, it’s usually not worth breaking your current fixed rate because after paying the break cost there is normally no discernible financial gain.

Get in touch with me today if you would like to explore your options.