When to Lock In Your Rate: Break Costs Explained

What Are Rate Lock-Ins?

When you apply for a home loan as a first home buyer, you'll often encounter the option to lock in an interest rate. A rate lock-in allows you to secure a specific fixed interest rate for your home loan application, even if rates change before settlement. This can provide certainty in your first home buyer budget and protect you from potential rate increases during the application process.

Rate locks typically last between 60 to 90 days, though some lenders offer longer periods. If rates rise during this time, you benefit from the lower locked rate. However, if rates fall, you're generally obligated to proceed with the higher rate you've locked in.

How Rate Lock-Ins Work for First Home Buyers

The process of securing a rate lock-in is relatively straightforward:

1. Submit your first home loan application through your mortgage broker
2. Receive pre-approval from your chosen lender
3. Request a rate lock-in for your fixed interest rate
4. Pay any applicable rate lock fee (typically ranging from $300 to $750)
5. Proceed with your property purchase within the lock-in period

For first home buyers using schemes like the First Home Loan Deposit Scheme or Regional First Home Buyer Guarantee, rate lock-ins work the same way. These low deposit options with a 5% deposit or 10% deposit can be combined with rate lock-ins to provide additional certainty.

Understanding Break Costs

Break costs are fees charged by lenders when you exit a fixed interest rate loan before the fixed term ends. These costs can be substantial and are often misunderstood by first home buyers.

When you take out a fixed rate home loan, your lender hedges against interest rate movements in the wholesale funding market. If you break your fixed rate contract early, the lender may incur losses - and these losses are passed on to you as break costs.

When Do Break Costs Apply?

Break costs typically occur in these situations:

• Refinancing to another lender before your fixed term ends
• Selling your property and paying off the loan early
• Making additional repayments beyond the allowed limit (usually $10,000 to $30,000 per year)
• Switching from a fixed interest rate to a variable interest rate mid-term

It's worth noting that break costs don't apply to variable interest rate loans. With a variable rate, you maintain flexibility with features like an offset account and unlimited redraw facilities.

How Break Costs Are Calculated

Lenders calculate break costs using a complex formula that considers:

• The difference between your fixed interest rate and current market rates
• The remaining time left on your fixed rate period
• Your outstanding loan balance
• The lender's wholesale funding costs

If interest rates have fallen since you locked in your fixed rate, break costs will typically be higher. Conversely, if rates have risen, break costs may be minimal or even zero.

For example, if you locked in a fixed rate of 5.5% and current rates are 4.5%, you might face break costs of $5,000 to $15,000 on a $500,000 loan with three years remaining. However, these figures vary significantly between lenders.

Avoiding or Minimising Break Costs

First home buyers can take several steps to avoid or reduce potential break costs:

1. Consider a split loan: Combine a fixed interest rate on part of your loan with a variable interest rate on the remainder. This provides some rate certainty while maintaining flexibility.

2. Check your loan features: Some fixed rate loans allow limited additional repayments (often $10,000 to $30,000 annually) without penalties.

3. Plan your fixed term carefully: Choose a fixed rate period that aligns with your likely ownership timeframe.

4. Review portability options: Some lenders allow you to transfer your fixed rate loan to a new property without break costs.

5. Time your refinancing: Wait until your fixed rate period ends before refinancing to avoid break costs entirely.

Rate Lock-Ins vs Break Costs: Key Differences

While both concepts relate to fixed interest rates, they apply at different stages:

• Rate lock-ins occur during your first home loan application process, before settlement
• Break costs apply after settlement, when you're exiting a fixed rate loan early

Understanding this distinction helps first home buyers make informed decisions about their home loan options.

First Home Buyer Considerations

As a first home buyer, you need to weigh the benefits of rate certainty against the flexibility you might need. Consider these factors:

• Your employment stability and income prospects
• The likelihood of needing to sell or refinance within the fixed period
• Current interest rate discounts available on fixed versus variable rates
• Your ability to make additional repayments
• Whether you'll need features like an offset account

First home buyer stamp duty concessions and first home owner grants (FHOG) can help reduce upfront costs, but these don't directly impact break costs or rate lock-in decisions.

Making the Right Choice

When buying your first home, understanding rate lock-ins and break costs is essential for managing your first home buyer checklist. While Lenders Mortgage Insurance (LMI) protects the lender, rate locks and break cost provisions protect their interest rate position.

Before committing to a fixed interest rate, discuss your circumstances with a qualified mortgage broker who can explain the specific terms and conditions of different lenders. Some lenders offer more favourable break cost formulas or longer rate lock periods.

The first home super saver scheme can help boost your gift deposit or savings, but your interest rate choice will impact your ongoing repayments for years to come. Take time to understand all aspects of your first home loan before making this significant commitment.

Whether you're exploring refinancing options or starting your journey as a first home buyer, Empire Road Investments can help you understand these complex products. Our team specialises in finding suitable home loan solutions for residents Australia-wide.

Call one of our team or book an appointment at a time that works for you to discuss your first home buyer eligibility and explore which interest rate structure aligns with your financial goals. Visit our book appointment page or learn more about our approach on our about us page.