Making lump sum payments and break fees

We’ve had a lot of people asking about lump sum payments, and we’re pleasantly surprised at just how many people have a little lump of cash lying around. It might be $20k, sometimes it’s $100k! Either way, people ask themselves if it’s better to sit on it or put it on the mortgage. 

While it may seem tempting to save it, you won’t earn as much interest in a savings account as you’ll pay in interest on a mortgage so from that perspective, making a lump sum payment is an excellent move.

However, once you put the money on your mortgage, you generally don’t have access to it anymore. Your mortgage will be reduced and your monthly payments will decrease, both of which are great, but your cash is now gone too.

Did you know you can structure your mortgage to put in your lump of cash,
and should the need arise, pull it back out again?

Many think revolving credit is the way to achieve this, and yes, it is one way of structuring things. Having an offset loan is another way of doing it that can suit some people.

Revolving home loans work like a big overdraft where your loan becomes your everyday bank account. Money flows in and out as you get paid and pay bills. You can easily access funds with a swipe of your card and therein lies the problem.

It’s why we are huge fans of loans that offer redraw. You can still access any ‘extra’ money you’ve put in but can’t get out with your eftpos card which means it’s much more likely to be preserved for when you really need it.

We had a customer who had been overpaying her mortgage over the years. She needed a new roof and gutters on her home. She asked us to arrange a loan top-up of $50k. But we were happy to advise that she didn’t need a top-up, she could use her redraw on the loan.

Redraw works best when your loan is on a floating interest rate, but it can also work if you prefer the certainty of a fixed rate. Most loans operate on the basis that the loan limit falls at the same speed as your loan balance, whereas loans with redraw don’t. It means that if you can reduce your limit quickly (by making higher payments or making a lump sum or both) then you’ll create a gap between your limit and balance – and that gap represents money you can pull back out.

Break fees

If you have a fixed-interest rate loan (not floating), you might be charged a break fee if you decide to make a lump sum payment before the fixed rate period ends. Basically, the bank loses out on the interest they would have earned if you had kept the loan for the full term, so they charge a fee to compensate for that. The break fee amount depends on the interest rate and how much the bank would have earned if you hadn’t paid back early.

If interest rates are falling, there’s a higher chance you’ll have to pay a break fee than if they were rising.

There is a formula, but it’s not as simple as Einstein’s theory of relativity; it looks like spaghetti. And you can’t work it out ahead of time; you have to work it out on the day because of all the variables involved. Here’s an example;

• If you have a mortgage of $250k, and the whole lot is fixed for five years on 7.5%.
• You want to make a lump sum payment of $50k.
• If the interest rate in the current environment were higher than your 7.5%, then there would be no break fee.
• But, if the interest rate in the current environment was lower, then;
  • For every $100k of the loan that you are going to repay, you multiply by one
  • Plus $1k for every percentage point difference
  • Plus $1k for every year you’ve got left on your fixed rate
  • Your break fee could be in the range of $2.5-3.5k

(% fall in interest rates since you fixed the loan) x (your loan balance) x (years until the fixed rate matures).

In the current environment where rates have been rising, break fees have been low, if not $0. But that could change if (when) interest rates start to fall.

Essentially, if you’re going to make a lump sum payment,
don’t wait for interest rates to start falling, do it while they are high.

The question to ask yourself is, do you want the ability to get that money back in future?

If not, put it on your mortgage.

If yes, still put it on the mortgage, but talk to us first about a structure to help you access it