Smart ways to understand rate lock-ins and break costs

As a tradie looking at buying your first home, you've probably heard about fixed interest rates and wondered what happens if you need to change your loan later. Rate lock-ins and break costs are two concepts that can significantly impact your financial situation, so let's break them down in plain English.

What Are Rate Lock-ins?

A rate lock-in is when your lender agrees to hold a specific interest rate for your first Home Loan application for a set period, usually between 30 to 120 days. This protects you from interest rate increases while you're going through the application process or waiting for settlement.

For tradies, this can be particularly valuable given the property market conditions. Here's how it works:

• Your mortgage broker secures a rate with participating lenders
• The rate is held for an agreed timeframe
• You're protected if rates rise during this period
• If rates fall, some lenders allow you to take advantage of the lower rate

Rate lock-ins are especially useful when:

• Interest rates are expected to rise
• You're building a home and settlement is months away
• You want certainty for budgeting purposes
• You're concerned about your borrowing capacity being affected by rate changes

Understanding Fixed Interest Rate Break Costs

Break costs come into play when you have a fixed interest rate loan and want to make changes before the fixed period ends. These costs can apply whether you want to:

• Pay out your loan early
• Switch to a variable interest rate
• Refinance to another lender
• Make large additional repayments beyond what's allowed

The break cost is essentially compensation to the lender for the interest they'll lose. It's calculated based on several factors:

1. The difference between your fixed rate and current market rates
2. The remaining time on your fixed rate period
3. Your outstanding loan amount
4. Current wholesale funding costs

How Break Costs Are Calculated

While the exact calculation varies between lenders, here's a simplified example:

Let's say you locked in a fixed interest rate of 4.5% for five years, but current rates have dropped to 3.5%. If you want to break your fixed rate with three years remaining on a $400,000 loan amount, the lender calculates their lost income over those three years.

The break cost could be substantial – sometimes thousands of dollars. However, if interest rates have risen since you fixed your rate, there may be no break cost at all, as the lender isn't losing money.

Strategies for Tradies

As someone in the trades industry, your income might fluctuate seasonally or based on project availability. Here are some approaches to consider:

Split Loan Strategy: Consider splitting your loan between fixed and variable interest rate portions. This gives you some rate certainty while maintaining flexibility.

Offset Account Benefits: If you choose a variable rate or partial variable rate, an offset account can help reduce interest while keeping your funds accessible for tools, equipment, or business expenses.

Consider Your Timeline: If you're likely to upgrade, renovate extensively, or move within a few years, a variable rate might suit your situation better than locking in a fixed rate.

Making Informed Decisions

When applying for a home loan, discuss these scenarios with your mortgage broker:

• Your likelihood of wanting to make extra repayments
• Whether you might refinance in the coming years
• If you're planning major renovations that might require additional borrowing
• Your comfort level with interest rate movements

First time home buyer programs and the Home Guarantee Scheme can also influence your decision. Some government initiatives work better with certain loan structures, and your broker can help you access Home Loan options from banks and lenders across Australia that align with these programs.

The Application Process Consideration

During the streamlined application process, you'll need to provide bank statements and documentation of your income. This is when discussing rate lock-ins becomes relevant – particularly if you're getting pre-approved and expect settlement to be weeks or months away.

First home owner grants (FHOG) and stamp duty concessions available to first-time buyers can affect your loan to value ratio (LVR), potentially helping you avoid lenders mortgage insurance (LMI). These benefits packages can influence whether you choose fixed or variable rates.

Understanding rate lock-ins and break costs helps you make informed decisions about your first investment property or family home. While fixed rates provide certainty, they come with potential exit costs. Variable rates offer flexibility but expose you to interest rate movements.

Remember, access to banks and lenders nationwide means you have options. Your mortgage broker can help you find loan structures that match your circumstances, whether that's investment loan options for your future plans or finding interest rate discounts for your current application.

Call one of our team or book an appointment at a time that works for you to discuss how rate lock-ins and break costs might affect your home loan strategy.