Written byBreak costs are the charges a lender passes on when a fixed rate loan is repaid or changed before the fixed term ends.
Also known as: break fee, early repayment cost, economic cost, prepayment cost
Key points
- They arise on fixed rate finance; variable rate loans normally have no equivalent charge, though other fees can still apply.
- Triggers include an early settlement, refinancing elsewhere, selling the asset, or large extra repayments.
- The amount is not set in the contract: it moves with market rates between the day you fixed and the day you break.
- Ask the lender for a written payout figure showing the break cost before you commit to anything.
- A termination fee is a separate flat charge, and both can appear on the same payout.
How break costs work
When you fix a rate, the lender arranges its own funding for that term. If you hand the money back early, it has to place those funds elsewhere at whatever the market offers on the day. Break costs recover that difference. If wholesale rates have fallen since you fixed, the lender is worse off and the charge can be substantial; if rates have risen, the cost may be small or nothing at all.
The calculation generally weighs three things: the amount being repaid early, the time left on the fixed term, and the gap between your fixed rate and the current cost of funds. Breaking a large balance with years still to run is the expensive case. Breaking a small balance near the end of the term is usually minor, which is why interest rate risk sits behind the whole idea.
When break costs apply
The usual triggers are paying the loan out in full, moving to another lender, selling the financed asset or property, switching from fixed to variable part way through, or making extra repayments beyond what the contract allows. Some contracts also charge when a facility is restructured, such as changing the term or the payment frequency.
Business equipment finance often carries the same idea under a different name: early termination charge, economic cost, or a payout formula written into the contract. Read that clause before signing, especially if you cycle vehicles or plant regularly, because what it costs to get out early is part of the real cost of the deal.
How to keep them down
Ask for a written payout figure before you act, and check how long the quote holds, because the number moves with the market. Then compare the charge against the benefit: if what you would save over the remaining term does not cover the break cost, waiting until the fixed period ends is often the better move.
At contract stage, look at what the fixed term is buying you. A shorter fixed period, a split between fixed and variable, or a contract with a defined allowance for extra repayments all cut the chance of a large charge later. A broker can run that comparison with you before you commit.
Example
A transport operator fixes a $200,000 equipment loan for five years. Two years in, the truck is sold and the loan has to be paid out. Because wholesale rates have fallen since the loan was fixed, the lender's payout figure includes a break cost of several thousand dollars on top of the balance owing, plus a flat administration fee. Had rates moved the other way, the break cost may have been close to nothing. The operator asks for the payout in writing before agreeing to a settlement date, then factors it into the sale price.
Not to be confused with
- Early settlement
- paying a loan out ahead of schedule, which is the event that can trigger a break cost
- Termination fee
- a flat contractual fee for ending an agreement early, not a market based calculation
Frequently asked questions
How are break costs calculated?
Lenders compare the rate you fixed at with their current cost of funds, then apply that difference to the amount repaid early over the time left in the fixed term. The method is set out in your contract and differs between lenders, and because the market moves the figure only holds for a short window.
Do break costs apply to variable rate loans?
Usually not, because the lender has not locked in funding at a set rate. Variable loans can still carry discharge or early termination fees, and business finance often has a payout formula of its own. Check the fees section of the contract rather than assuming there is nothing to pay.
Can I avoid break costs?
Sometimes. Waiting until the fixed term ends avoids them entirely. Staying within any contractual allowance for extra repayments, choosing a shorter fixed period, or splitting between fixed and variable all reduce your exposure. Ask what the payout would be before you make a decision either way.
Are break costs tax deductible?
Where the borrowing was for business or other income producing purposes, break costs are generally deductible, though the timing and treatment depend on the loan and how it was used. Private borrowing is treated differently. Confirm the position with your accountant or the ATO before you lodge.
How do I find out what my break cost will be?
Ask the lender for a payout figure in writing, stating the date you intend to settle. The quote will itemise the balance owing, the break cost and any fees. Because the market moves, quotes expire quickly, so line up your settlement date before requesting one.
Related terms
Fixed rate
A fixed rate is an interest rate locked in for a set term, so the rate and usually the repayments do not change until that term ends.
Read definitionEarly settlement
Early settlement is paying a loan or lease out in full before the end of its term using the lender's payout figure, or bringing a property settlement date forward.
Read definitionRefinancing
Refinancing is replacing an existing loan with a new one, from the same or a different lender, to change the interest rate, term or features, or to release equity.
Read definitionTermination fee
A termination fee is a contractual charge for ending an agreement before its agreed end date, or for triggering a contract exit event.
Read definitionVariable rate
A variable rate is an interest rate that can move up or down over the life of a loan, following the lender's benchmark and its margin.
Read definitionPayout
A payout is the total amount needed to close a loan or lease on a given date: the balance owing, accrued interest and any break costs or fees.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.