Breaking a fixed rate – it’s all about the costs!
Over a decade ago now, way back in 2003, I wrote an article regarding the true cost of breaking a fixed rate loan contract. At that time, much like now, there was a lot of hype around some of the fixed product offerings from the big banks, which just happened to coincide with an extended period of official interest rates sitting at then thirty year lows.
What I don’t at all find surprising is that my stance on fixing one or more loan products as an investor has not at all changed over that 11-year period. Because I know from experience and research that borrowers are almost always worse off in fixed rate scenarios.
So I’ll tell today’s readers what I told those property investors who read this more than a decade prior…before you rush out and fix your interest rate, it is essential that you fully understand what costs may be payable if you refinance or repay the loan during the fixed term.
This is where the whole issue of flexibility in your borrowing structure comes into play. As soon as you start locking yourself in to various aspects of, or additions to a mortgage product, you start to sacrifice that all-important flexibility of funds and importantly, equity.
When costs can spiral
Most lenders will charge what’s referred to as an “economic cost” if you restructure or refinance during a fixed rate period. The lender may also charge you a small discharge fee, although this is common with all loans (fixed and variable).
The ‘economic cost’ is the Bank’s reasonable estimate of its loss (if any) from the early repayment of the loan. In other words it is the difference between the lender’s cost of funds at the start of the relevant fixed rate period and its cost of funds at the date of termination or prepayment, over the remainder of that period.
Bottom line, if fixed interest rates start heading downwards at that point, you can bet it will cost you more to break free of your fixed contract. Think about it, if you break your agreement just before it starts to look lucrative in the lender’s eyes, they will seek to recoup more of that lost profit by way of exit fees and charges.
The best indication is to consider the prevailing fixed rates at the time you intend breaking the fixed rate.
Ultimately, like everything else to do with a well planned and considered property investment portfolio, whether or not you fix all or a portion of your loans should come down to your own ‘big picture’, rather than the latest ‘big product promotion’.
Weigh up the pros and cons of fixing. While it can be good to have a set amount to repay regardless of what is happening to the interest rates (particularly when they are going up!), you should always understand what costs may be involved if you break a fixed rate (or any loan for that matter). Because, you know, it’s all about the gains.
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Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: firstname.lastname@example.org
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