Breaking our mortgage for a lower rate will cost $20,000. Why?
A few years ago we took out a fixed rate mortgage, at 9%. We could now refinance at about 7%, which will make a big difference to our monthly payment. Our bank has quoted us a figure of close to $20,000 on top of the current debt to let us out. Surely this is a rip-off?
When you and the bank agreed on a fixed interest rate, you wanted protection against rates going up and increasing your repayments. On its part, the bank had locked in an earning rate, and would do very nicely if rates went down. That was a commercial bargain.
The bank is saying that you cannot have the best of both worlds - if rates went up, you benefited, and if they went down the bank benefited. If you now want to end the deal, the loan documents normally provide a formula for working out what the bank will lose, and this is called the “break cost”. Most deals can have both an up and a down side, and right now you are suffering the down side.
