The Dangers of Fixed Rates
The dangers of Fixed Rates is a topic that has been covered many times but a recent announcement from a lender regarding a change in their policy highlighted the need to read1K0-001 the fine print!
As you read this, you need to keep in mind that the policies outlined represent the policies of one lender and, whilst they may not apply to your lender, they do provide a good understanding of how Fixed Rates operate in general.
When you agree to have some or all of your loan operating on a Fixed Rate basis, you are making a commitment to stick with that arrangement for the duration of the loan but if you don't comply with the full terms of this commitment, you may end up being hit with a penalty by your lender. This fee may go under a variety of names but is generally referred to as a Fixed Rate Break Fee.
A Break Fee could be charged to fixed rate Home Loans if:
you repay the fixed rate loan during the fixed rate period;
break out of the fixed rate during the fixed rate period; or
you pay more than the nominated repayment amount and you exceed the lenders limit for extra repayments. Some lenders give you a maximum amount that you can pay in extra repayments in a 12 month period (this could be as high as $10,000 p.a.) but there is at least one lender that bases this on a month by month basis (and only allows an amount of $500 in any one month).
The reason that a lender charges the Fixed Rate Break Fee is that one of the ways that they raise the funds is by borrowing money at fixed rates on the money market at wholesale interest rates. If you end up making payments in excess of your normal payments or you break the fixed rate or payout the loan early, the lender must still pay the agreed wholesale rate and if1K0-002 the wholesale swap rates are lower at the time of the repayment, the lender makes a loss.
The care that you need to take when making extra repayments is extreme and you need to make sure that you understand the rules that do apply for your lender.
For instance, with the lender that looks at the repayments on a month by month basis, there are a number of interesting factors:
the monthly limit of $500 applies on a month by month basis based on the due date for the loan so it is not based on a calendar month;
the limit of $500 does not carry forward so it is a classic case of use it or lose it; and
you can pay an extra $500 per month without any penalty but if you pay an extra $501 in that month, then a penalty is applied to the whole extra repayment of $501 and not just the extra $1!
Probably the most alarming aspect with all of this is that if you are making fortnightly repayments and including an extra amount of $250 per fortnight because you are committed to paying your loan off quicker, then you would need to be very careful as there would be two months in every year where you would end up making three repayments. Your total extra repayments would then be $750 for those two months and you may be hit with break costs on the wholePGCES-02 $750!
There is nothing wrong with anything that this lender is doing but unless you are aware of the potential dangers, you could end up with some nasty surprises when you get your next home loan statement!
As you read this, you need to keep in mind that the policies outlined represent the policies of one lender and, whilst they may not apply to your lender, they do provide a good understanding of how Fixed Rates operate in general.
When you agree to have some or all of your loan operating on a Fixed Rate basis, you are making a commitment to stick with that arrangement for the duration of the loan but if you don't comply with the full terms of this commitment, you may end up being hit with a penalty by your lender. This fee may go under a variety of names but is generally referred to as a Fixed Rate Break Fee.
A Break Fee could be charged to fixed rate Home Loans if:
you repay the fixed rate loan during the fixed rate period;
break out of the fixed rate during the fixed rate period; or
you pay more than the nominated repayment amount and you exceed the lenders limit for extra repayments. Some lenders give you a maximum amount that you can pay in extra repayments in a 12 month period (this could be as high as $10,000 p.a.) but there is at least one lender that bases this on a month by month basis (and only allows an amount of $500 in any one month).
The reason that a lender charges the Fixed Rate Break Fee is that one of the ways that they raise the funds is by borrowing money at fixed rates on the money market at wholesale interest rates. If you end up making payments in excess of your normal payments or you break the fixed rate or payout the loan early, the lender must still pay the agreed wholesale rate and if1K0-002 the wholesale swap rates are lower at the time of the repayment, the lender makes a loss.
The care that you need to take when making extra repayments is extreme and you need to make sure that you understand the rules that do apply for your lender.
For instance, with the lender that looks at the repayments on a month by month basis, there are a number of interesting factors:
the monthly limit of $500 applies on a month by month basis based on the due date for the loan so it is not based on a calendar month;
the limit of $500 does not carry forward so it is a classic case of use it or lose it; and
you can pay an extra $500 per month without any penalty but if you pay an extra $501 in that month, then a penalty is applied to the whole extra repayment of $501 and not just the extra $1!
Probably the most alarming aspect with all of this is that if you are making fortnightly repayments and including an extra amount of $250 per fortnight because you are committed to paying your loan off quicker, then you would need to be very careful as there would be two months in every year where you would end up making three repayments. Your total extra repayments would then be $750 for those two months and you may be hit with break costs on the wholePGCES-02 $750!
There is nothing wrong with anything that this lender is doing but unless you are aware of the potential dangers, you could end up with some nasty surprises when you get your next home loan statement!
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