Key Post Understanding Fixed Rates breakage costs

RedOnion

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Understanding Fixed Rate breakage costs (Updated May 2019)

Summary

The manner in which lenders calculate their breakage costs is set down under new legislation introduced in 2016.

The interest rates charged by the lender to their customers are not relevant.

As of now, May 2019, the rates at which banks lend to each other is close to zero.
If you fix now, there will only be a breakage fee if either:
1. Rates fall further, or
2. Rates remain at this mow rate, but time has passed so your break fee is measured against a shorter time frame.


How it works:
When you seek to break a fixed rate mortgage early, the breakage cost can't be more than the difference between the rate the bank was able to borrow money at for the original term in the inter-bank markets, minus what they can get for depositing the money in the inter-bank markets for the remaining term, times the remaining term.

If you are paying off a lump-sum, rather than the entire balance, the breakage fee is only calculated on the lump sum amount.

Breakage fees are calculated on inter-bank market rates, so are independent of any pricing decisions a bank makes in setting rates charged to customers.

More details below, with worked examples using theoretical scenarios.

Fixed Mortgage Rates - what if variable rates go down?
We probably all remember (or may even have experienced ourselves) quotes of 10K and more for people to break mortgages when rates fell in the past, particularly when rates fell rapidly after the initial reaction to the financial crisis in 2009. It's a memory that frightens many people away from fixing their mortgages.

However, those large break costs were the result of 2 factors:
1. Actual market rates (bank funding costs) were coming down dramaticaly, and it cost banks money to break their fixed hedging early, and
2. There was a bit of 'wiggle room' in how banks calculated breakage costs.

Calculating Breakage costs
Since 2016, the calculation is governed by the 'European Union (Consumer Mortgage Credit Agreements) Regulations 2016' http://www.irishstatutebook.ie/eli/2016/si/142/made/en/print

I have included a table below showing how each lender currently calculates break costs, as per their T&C's.

The regulation unfortunately doesn't specify exactly how the breakage is to be calculated, but it is quiet specific that the cost to the consumer should not exceed the financial loss to the bank. A bank must provide a written breakage quote to the consumer, and list all assumptions used. All assumptions must be reasonable, and justified.

What this boils down to is that the breakage cost can't be more than the difference between what the bank was able to borrow money for for the original term in the inter-bank markets, minus what they can get for depositing the money in the inter-bank markets for the remaining term, times the remaining term.


If market rates remain as they are now, to break a 2 year rate taken now in 1 year's time would cost approx 0.2% of the balance.

In the case of a rising interest rate market, the resulting breakage could be Nil.

Taking a fixed rate mortgage is really taking a view on the wholesale interest market for the next few years.

NOTE: Time remaining on fixed rate is a variable in the calculation of the break fee. So if you are exiting a 10 year fixed contract, a small move in interbank rates is multiplied by 10 so can result in a material break fee. For example a 0.2% fall in 10 year interbank rates (which has happened so far in 2019) would result in a break fee of 2% of the mortgage balance.


Some theoretical Examples:

Example 1 - I fix and I break immediately
I fix my rate with Bank of Ireland today for 2 years at 3.2%.
I decide 1 month later that I want to switch to EBS to get the 2% cash back from them.
The rate BoI borrowed from the market last month, and the rate they can get for lending to the market today is the same, so there might be a marginal breakage cost.
(In this case there might be a marginal breakage cost, as there are dealing costs in settling fixed rate contracts)


Example 2 - The rates at which banks lend to each other fall
I borrow €100,000
I fix my rate with Bank of Ireland today for 2 years at 3.2%. BoI's funding rate in the market is 0%.
After one year, I decide I want to switch to another lender.
The one year inter-bank Market rate is now -0.4% in the market.
Bank of Ireland can relend to the market at -0.4% instead of the 0% they borrowed at so the breakage fee is
€100,000@ 0.4% x 1 year = €400


Example 3 - rates rise
I borrow €100,000
I fix my rate with Bank of Ireland today for 2 years at 3.2%. BoI's funding rate in the market is 0%.
After one year, I decide I want to switch to another lender.
The one year interbank rate is now +0.25%.
Bank of Ireland can relend at +0.25% instead of the 0% they originally borrowed for, so there is no cost to them, so there is no breakage fee to the customer.



Can I Overpay without a Penalty?
A question that pops up in a few threads discussing fixed rate mortgages is whether or not you can overpay during the fixed rate term before the bank check if a break fee is payable.

From what I can gather each of the banks rules are as follows (any corrections welcome).

I have based this on each Banks Terms & Conditions. I won't comment on whether the banks system / processes can be circumvented as these system failures cannot be relied upon:

AIB: No early repayments allowed without checking break fee

Bank of Ireland: The greater of EUR65 or 10% of normal repayment each month. However, this is done by increasing monthly repayment, and can’t be paid in as a lump sum. There are examples on AAM of posters who have set up a monthly overpayment, while on variable, being able to continue this once they have fixed, and got confirmation from BOI on same.

EBS: No early repayments allowed without checking break fee

KBC: 10% of the initial balance can be repaid early at any stage during the term without incurring a break fee. This is a cumulative limit of the fixed term, so if for example you have fixed for 5 years, and you overpay by 10% of the balance in year 1, that's your limit used up for the 5 years.

PTSB: No early repayments allowed without checking break fee

Ulster Bank: 10% of the balance at the beginning of the calendar year can be repaid each year without triggering a break fee calculation.


How does each lender calculate their Break Fee?

I have included below a summary of the fixed breakage fees in place across all the major mortgage providers in Ireland (wording paraphrased in some cases).

As mentioned in an earlier post, AIB base their break costs on the difference between your fixed rate, and their fixed rate currently applicable for the remaining period.

ALL the other banks base break costs on market rates of some description - whether cost of funds, deposit rate available, or interbank SWAP rates.

BankR1R2Source / Notes
AIB (method 1)the fixed interest rate applicable at the start of the fixed interest periodthe fixed interest rate applicable as at date of premature payment/conversion, for the unexpired fixed interest rate periodhttps://aib.ie/our-products/mortgages/Home-Mortgages-Regulatory-Information
AIB (method 2)the cost of funding at the start of the fixed interest period the cost of funding applicable as at date of premature payment/conversion, for the unexpired fixed interest rate periodhttps://aib.ie/our-products/mortgages/Home-Mortgages-Regulatory-Information
(paraphrased - AIB updated T&C's April 2019 - they calculate on 2 methods, and quote customer based on the lowest of the 2)
Havenoriginal cost of funds – The cost of funds for Haven for the fixed rate period at the time the fixed rate period commenced.cost of funds for the fixed rate period remaining – Fixed rate period. The cost of funds used will be as of 5pm the day previous to the request to calculate the early redemption charge.https://www.havenmortgages.ie/useful-information/regulatory-information#false
EBSoriginal cost of funds - The cost of funds for EBS for the fixed rate period at the time the fixed rate period commenced.cost of funds for the fixed rate period remaining - Fixed rate period. The cost of funds used will be as of 5pm the day previous to the request to calculate the early redemption charge.https://www.ebs.ie/mortgages/home-mortgages-regulatory-information
BOIthe annual percentage interest rate which was the cost to us of funding an amount equal to “A” for the originally intended fixed rate periodthe annual percentage interest rate available to us for a deposit of an amount equal to “A” for a period equal to “D”https://personalbanking.bankofireland.com/borrow/mortgages/information-and-legal-notices/
KBCThe Fixing Rate prevailing at the date of the existing fixed rate applying to the loan was set (Fixing rate is Cost of Funds)The Fixing Rate prevailing at the switching/redemption date for the unexpired time period of the Fixed Rate Period (Fixing rate is Cost of Funds)https://www.kbc.ie/KBC/media/Mortgages-PDFs/Mortgage-App-Form-Existing-Customer-28042017.PDF
PTSB“I” is the swap/market fixed interest rate for the term of the Fixed Rate Period at the date of its commencement“S” is the swap/market interest rate for the remaining fixed period,https://www.permanenttsb.ie/globala...tsb-personal-and-business-banking-charges.pdf
Ulster Bankmeans the interest rate available to the lender for funds placed in the money market on the start date of the relevant fixed rate period for the duration of the relevant fixed rate periodmeans the interest rate available to the lender for funds placed in the money market on the date of the proposed early repayment, lump sum repayment or interest rate conversion for the remainder of the relevant fixed rate period.http://digital.ulsterbank.ie/personal/mortgages/fixed-rate-mortgages.html
Note, in addition to this, Ulster Bank cap all break fees as 6 months interest, so break fee can never exceed 6 months interest

Non-bank lenders may have higher breakage fees because their funding models are different. Worth challenging any high break costs, as the break cost cannot be more than the actual cost to the lender.
 
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RedOnion

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So, should I Fix my interest Rate? (Updated May 2019).

(In progress)


Note, the analysis here does not apply to Tracker mortgage holders. It is based on a New Business customer, or an existing Customer on a standard variable rate.

AIB: Prior to April 2019, AIB did not compete on fixed rates. But, with the lowering of the fixed rates, it is now worth considering.
For those on the lowest LTV variable rate, they are paying 2.75%, variable.
They can get 2.85% fixed for 3, 4, or 5 years so buy security for an extra 0.1%.
It's a more clear cut decision for those on higher LTV rates, or SVR. You can fix for a long term, getting security, and save money.
Note: AIB is unusal in that their longer term fixed rates (3 years +) are lower than their shorter term fixed rates.

BOI: I cannot stress this enough: BOI SVR customers should FIX. BOI freely admit that they are pursuing a policy of encouraging customers to fix.
Their varible rates (depending on LTV) vary from 3.9% to 4.5%.
The same fixed rates are available, regardless of LTV.

EBS: Copy & paste advice re BOI.

KBC:

PTSB:

Ulster Bank:
 
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Sarenco

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Good post Red Onion - that all looks right to me and your key point is well made.

It might be worth noting that BOI have been very open about the fact that they are deliberately incentivising customers to fix as they take the view that the current interest rate environment is abnormal. As such, the discounted fixed rates (relative to variable rates) that we are currently seeing may not be reflective of a dysfunctional market but rather a view on the future trajectory of interest rates and the impact that might have on default rates.
 

Brendan Burgess

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Hi Red

Am I right in saying:

Up to 2016, banks could set the breakage cost, more or less, at their own discretion.

Since 2016, the rules have changed. As inter-bank rates have fallen over the past few years, there will be a break cost, but it is likely to be smaller than what it would have been had this legislation not been introduced.

Brendan
 

RedOnion

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Hi,

Prior to 2016 the breakage costs were covered by the consumer credit act. In summary each bank could come up with a calculation, which had to be approved by CBI. There were different variables, some of which were linked to bank pricing policy rather than external market rates.

The big break costs in 2009 were largely due to rapidly falling interbank rates, but they were difficult to challenge.

Under new regulations it's an offence for a bank to add anything to their actual break costs.

I'm not sure if the regulation applies to fixed rates entered into before it was enacted.

R.
 
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RedOnion

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Rates have been relatively stable since around march 2016. However the 1 year rate is still less than the 2 year rate, so even if rates remain completely unchanged, there would still be a break cost for exiting a 2 year rate after 1 year. But it'd only be about 20bps of the balance.
 

Brendan Burgess

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Hi Red

Are these the sections of the Act which cover it?

My summary of this in plain English


A lender shall be entitled to charge a fair and objective break fee, where justified, for possible costs directly linked to the early repayment of a fixed rate mortgage.

Any such break fee shall not exceed the financial loss of the creditor.

A lender shall not be entitled to impose a sanction on the borrower for early repayment of a fixed rate mortgage

The actual act

Early repayment



26. (1) A consumer has a right to discharge fully or partially his or her obligations under a credit agreement prior to the expiry of that agreement. In such cases, the consumer shall be entitled to a reduction in the total cost of the credit to the consumer, such reduction consisting of the interest and the costs for the remaining duration of the contract.



(2) A creditor shall be entitled to fair and objective compensation, where justified, for possible costs directly linked to the early repayment, but shall not impose a sanction on the consumer, and any such compensation shall not exceed the financial loss of the creditor.



(3) Notwithstanding paragraph (2) and without prejudice to paragraph (4), a creditor’s entitlement to compensation under this Regulation shall arise only in the circumstances where the borrowing rate provided for in the credit agreement:-



(a) may not be changed, or



(b) may not be changed over a period of at least one year, or



(c) may not, for a period of at least five years, exceed the rate applicable on the date of the making of the credit agreement by more than two percent.
 
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RedOnion

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Yes that's a good summary.
I'd add in the section re providing a written quote, with assumptions, without delay.
 

Brendan Burgess

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Rates have been relatively stable since around march 2016. However the 1 year rate is still less than the 2 year rate, so even if rates remain completely unchanged, there would still be a break cost for exiting a 2 year rate after 1 year. But it'd only be about 20bps of the balance.
Ah, that is a point I missed.

When I took out my mortgage 5 years ago, the rate for 5 year inter-bank lending was 5%, say and the rate for two year lending was 3%.
Today with two years to go, the rate for two year lending is still 3%.

So although rates have not fallen, the shorter period means that the lender has a loss in re-lending the money as the rate for two years is lower than the rate for 5 years.

Brendan
 

RedOnion

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Ah, that is a point I missed.

When I took out my mortgage 5 years ago, the rate for 5 year inter-bank lending was 5%, say and the rate for two year lending was 3%.
Today with two years to go, the rate for two year lending is still 3%.

So although rates have not fallen, the shorter period means that the lender has a loss in re-lending the money as the rate for two years is lower than the rate for 5 years.

Brendan
Yes, you've put it better than I did.
 

Brendan Burgess

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Note, if you are an AIB customer, it appears that they are interpreting the legislation differently from the other lenders and if you are quoted a high cost, it may be worth challenging.

Hi Red

Is there anything published on the interpretation of this?

Has the Central Bank issued any guidelines? Has the CPPC issued any guidelines?

Have the banks published their interpretations?

Brendan
 

Brendan Burgess

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Ulster Bank explains it as follows. There appears to be a bit left out which I have guessed at [in green] and highlighted the bit in the example in red.

Early Redemption Charge
If you pay off a fixed rate mortgage before the end of the agreed fixed period or change to another interest rate before the end of the agreed fixed rate period, an early redemption charge will be applied. This charge will be either [6 months' interest] or an amount calculated using this formula, whichever is lower:
Redeemed amount x (R - R1) x Time remaining in days until the end of the fixed rate period) divided by 360.

In this formula:
Redeemed amount means the estimated average loan balance between the time of the proposed repayment or interest rate conversion and the end of the relevant fixed rate period, assuming that no such repayment or interest rate conversion takes place and that all scheduled repayments of the loan are made by the borrower under the terms specified in the loan offer. Where a lump sum repayment is made, redeemed amount shall mean the amount of the lump sum repayment.

R means the interest rate available to the lender for funds placed in the money market on the start date of the relevant fixed rate period for the duration of the relevant fixed rate period.

R1 means the interest rate available to the lender for funds placed in the money market on the date of the proposed early repayment, lump sum repayment or interest rate conversion for the remainder of the relevant fixed rate period. The rate applied is based on the remaining fixed rate term of the mortgage, rounded to the nearest month if less than one year or to the nearest year if greater than one year.

Time means the number of days from the date of early repayment, lump sum repayment or interest rate conversion to the end of the relevant fixed rate period.

Six months interest is the estimated interest that would be payable in the six months following the proposed repayment or interest rate conversion.

Typical Example

In the example below, a customer took out a 5 year fixed mortgage at a rate of 5.00% on 1st January 2014. On 4th January 2015, the mortgage outstanding was €100,000 and the customer opts to break out of the fixed rate. The breakage cost calculation is:

Redeemed Amount = €87,832.42
R (Market rate on 1st January 2014) = 2.849% (for a 5 year interbank deposit by Ulster Bank)
R1 (Market rate on 4th January 2015) = 1.713% (for a 4 year interbank deposit by Ulster Bank)
Time = 1,457 days
Breakage Calculation = (Redeemed Amount x (R-R1) x Time) divided by 360 = (€87,832.42 x (2.849% - 1.713%) x 1,457)/360 = €4,038.22
Six Months Interest = €2,500
Therefore, in this case the customer would be charged the lesser amount of the six months interest i.e. €2,500.

When your fixed rate mortgage expires you can revert to the Standard Variable Rate or any other mortgage product that you may be offered at this time. As Standard Variable Rate is not linked to the European Central Bank base rate (ECB), the rate can increase at any time even if there is no change in the ECB base rate.
 
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RedOnion

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I'm not aware of any CCPC / CBI guidance on this.

I never thought to look at UBs wording, but strictly speaking it's a more technically correct interpretation than in my OP (I'll update).

If Dilosk applied the same definition of R1, they'd be fine, and in the example of @Moon light in another thread, the breakage cost would be c. 80% lower.
 

ThatNewGuy

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Hi, what's the best source to view the interbank lending rate? Tradingeconomics says it's -0.33%. Is that correct? Currently deciding between 1yr and 3yr fixed, and if going 3yr would like to know what I'm pegging myself against for a break if I decided to do it
 

daveyboy31

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Folks-does anyone know has the EURBID rate referred to above used by BOI fallen recently. We paid €15,000 off last Oct/Nov without penalty. We are in a position to pay more off now but when we rang last week and again today we were advised there would be a penalty. We are fixed for 10 years so it would be quite costly. We are hoping to wait for the rates to swing back around in our favour so I assume we should just keep an eye on this Eurbid rate and wait for it to rise? Thanks
 

NoRegretsCoyote

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Folks-does anyone know has the EURBID rate referred to above used by BOI fallen recently. We paid €15,000 off last Oct/Nov without penalty. We are in a position to pay more off now but when we rang last week and again today we were advised there would be a penalty. We are fixed for 10 years so it would be quite costly. We are hoping to wait for the rates to swing back around in our favour so I assume we should just keep an eye on this Eurbid rate and wait for it to rise? Thanks
They are obliged to provide you the parameters used in the calculation (and a worked example) in writing, and on request.

I've had worked examples from BoI in the past and the arithmetic in one case was complete garbage. So it's worth checking yourself.

You can request this every few weeks if you like.
 

RedOnion

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advised there would be a penalty
Did you tell you the amount?
Interbank Interest rates have moved around a bit, particularly in December.
Would you save more waiting for break fee to be zero than you would save in interest by making the repayment now?
 

daveyboy31

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They are obliged to provide you the parameters used in the calculation (and a worked example) in writing, and on request.
Cheers, will ask them for that. At least then , I'll know the original rate from we took the loan out in June
Did you tell you the amount?
Interbank Interest rates have moved around a bit, particularly in December.
Would you save more waiting for break fee to be zero than you would save in interest by making the repayment now?
Hi, my wife was talking to them . I think it was 250 for 10000 and we are on a 3.3% rate so I suppose it depends how long we wait and if it's likely to change. We will be paying off more than that though ( about 35k) . We were a bit complacent as we had wrongly assumed interest rates were as low as they would go. Essentially I suppose it's a question of speculating on whether the rates will go up soon. Cheers though you are right . It is worth factoring in the interest we are paying
 
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RedOnion

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Last June
Ah, because you've fixed for 10 years, even small changes mount up. 10 year rate has fallen by about 0.3% since June. Stock market volatility towards the end of last year hammered long term rates.

The other danger with waiting for rates to rise is you'll hit a point you're compared to the 9 year rate.

Don't forget with BOI you can increase your monthly repayment by 10% without triggering a break fee. Small beer, but worth doing if you've extra cashflow.
 
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