Breaking the Bank

Last week, we did what I had thought up until then was only possible with a good amount of grovelling, indirect bribery, and other acts brought about by both emotional and financial desperation.

We broke our mortgage.

To my surprise, this was as easy as sending an email, and now I’m much more knowledgeable about what we can and cannot do when committing to a lifetime of debt to the bank.

When we bought our house, we split our mortgage, fixing part of it for two years at just over 9%. At the time this was a reasonably good deal, with floating interest rates hovering over 10% for close to a year.

Since then however, interest rates have dropped by nearly 3%. Currently the floating rate is at 7%, and there is considerable speculation that it will fall further. Our fixed mortgage suddenly didn’t look so attractive anymore.

I wanted out.

We decide to discuss our options with the bank.

By entering into a fixed-term loan, we agreed to pay the bank a fixed amount of interest over the agreed term.

To get out of this, meant we were essentially asking to break a legal binding contract, for no other reason that it was now more financially appealing for us to do so.

It turns out this is possible.

Here is what I learned:

How much does it cost to break a fixed-term mortgage?

While banks cannot break a fixed term agreement when interest rates rise, they are required by the NZ banking ombudsman to give borrowers the opportunity to break at any time.

However, this is not a ‘get-out-free’ card. And in order to break the contract, the borrower must pay the difference in interest between the current rate and fixed rate if it is higher. This amounts to the interest which the bank would otherwise have received.

So for example, if I had $100,000 fixed for two years at 10%, and after a year wished to break this as the current interest rate had dropped to 7%, I would need to pay the bank the difference in interest, in this case 3% of $100,000, or $3000.

The exact formula used varies from bank to bank. But what it means, in theory, is that if I were to then to re-fix my $100,000 mortgage at the new 7% rate for a year, at the end of that term both I and the bank would be off the same.

This is non-negotiable.

However, because banks are banks, they will also charge costly transaction fees of around $100 – $500 for this service.

These are negotiable.

When is it worthwhile to break a fixed-term mortgage?

  • If you are in a position to pay off more than what you agreed to, either in lump-sums or increased weekly payments.
  • If you have reason to expect interest rates will drop further.

Under what other circumstances would it be necessary to break a fixed-term mortgage?

  • Change of financial circumstances, meaning it was no longer possible to meet repayments.
  • If the property is sold, and the mortgage needs to be discharged in order to transfer the title to the new owner.

What if it’s a fixed term mortgage of $200,000 for five years and it will cost $35,000 to break? Isn’t that negotiable?

Fixing a mortgage for five years is a gamble.  Things change. It may become necessary to sell the property within two years, there might be loss of income, or a significant drop in interest rates as we are seeing now.  This is a risk borrowers take when entering a fixed-term agreement, but they also stand to gain considerably if interest rates were to rise.

However, just as it would be unreasonable for the bank to break a five year contract if it suited them, it is unreasonable to expect the bank to negotiate the amount of interest rate you committed to pay when entering the contract.

Their only obligation is to allow you to break it (provided you pay the potential lost interest on the loan).

So, if it’s too expensive to break what other options are there?

  • You can agree to break only part of the mortgage, but the same formula for this amount applies as well.
  • You can increase your weekly payments, but again the terms vary from bank to bank, and are likely to incur fees.

I’ve broken the mortgage, now what?

Go shopping.

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