What ASIC says it is
ASIC’s guide for lenders on early termination fees describes break fees, which it notes are sometimes called break costs, as a fee “said by lenders to be charged to recover the economic cost to the lender of a customer terminating a fixed rate loan before the end of the fixed rate term. It is not charged for variable rate loans.”
Moneysmart lists three moments it can arrive: switching to another home loan, selling the property, or paying the loan off early. AFCA adds a fourth: its approach covers a fixed-rate loan that is partly prepaid, as well as one that ends.
How it is usually worked out
ASIC explains that break fees are usually calculated from the gap between the fixed rate on the loan and the rate prevailing on the day it ends, across the part of the fixed term still to run. Either rate could be a retail or a wholesale rate. The direction matters: breaking a loan whose fixed rate is below the prevailing rate brings a lower break fee, or none, than breaking one fixed above it. Moneysmart puts the same point the other way round: generally, the further rates have fallen since the loan was fixed, the higher the fee.
The ACCC, in its 2020 home loan inquiry, named three things the amount depends on: how interest rates have changed since the rate was locked in, the remaining fixed-rate period, and the loan balance.
How AFCA checks one
AFCA generally does not review the level of a fee. When a complaint is about a particular fee, it looks at four things, in this order:
- whether the fee was properly disclosed to the customer;
- whether it was charged as the customer’s contract allows;
- whether it was applied correctly, given the scale of charges the firm generally uses; and
- for a loan the National Credit Code covers, whether the break cost is more than a reasonable estimate of the lender’s loss from the early end.
For a loan the Code covers, AFCA says it reads the contract and the lender’s information and also makes its own estimate of the loss. A lender usually works from its cost of funds, which AFCA accepts it need not reveal, so AFCA compares movements in published wholesale market rates instead: the rate for the loan’s original fixed term, and the rate for whatever was left of it when the loan was repaid. Its estimate also takes in the amount repaid, the remaining term, the contracted repayments and the time value of money.
Paying a break cost does not stop a later complaint. If AFCA concludes that some or all of it was charged incorrectly, it says it will require that amount to be refunded. AFCA also notes the complaints it often sees: borrowers who say they were never told a break cost would apply, or that the explanation they got did not describe how it would be calculated.
Rules that hold it in place
What the law and ASIC say about the size
No raising it mid-term. While the rate is fixed, section 70 of the National Credit Code says the contract “cannot be changed unilaterally by a credit provider so as to increase, or change the method of calculation of a fee or charge so as to increase, a fee or charge” payable on early termination or on prepayment.
Tens of thousands is possible. ASIC writes that break fees for fixed rate loans “can be substantial. For example, in some circumstances, these fees can be tens of thousands of dollars.”
The general ban has an exception. From 1 July 2011, the regulations prohibit early termination fees on residential loans, with limited exceptions; break fees are the example ASIC gives of a fee the ban does not reach.
The warning ASIC suggests lenders give
ASIC’s view is that a break fee should be explained in plain English, giving the amount or, where the amount cannot be known yet, the method of calculation, and given enough prominence that a borrower sees the consequences of ending a fixed rate early. It suggests lenders consider a prominent warning that includes:
“(a) a statement that if a consumer seeks to terminate the contract early they could have to pay break fees, which can be substantial (in some circumstances, tens of thousands of dollars);
(b) a reference to where or how a consumer can find more information about how break fees are calculated; and
(c) a description of the uncertainty and risks associated with break fees.”
ASIC, Regulatory Guide 220, RG 220.127
Its examples of that uncertainty, in order: a substantial drop in wholesale rates after the loan is fixed could mean a very high fee; nobody can reliably predict which way rates will move, how far or when; and a fixed loan may not suit someone who plans, or might want, to end it within the fixed period.
How a break cost should be stated
Moneysmart’s list of questions to ask before choosing a fixed-rate loan includes what fees or charges could apply on refinancing before the fixed period ends. Two points from the bodies above bear on how a break cost is stated:
- AFCA’s approach covers a break cost that has been quoted as well as one that has been charged.
- ASIC says that where the amount cannot be known yet, the method of calculation should be explained in plain English.
A break cost is one line in the sum. The others are on the next pages, starting with insurance a new lender may ask for.
Next: mortgage insurance, a second time, then the serviceability buffer. Or go back to the six pages.