If our fictitious couple John and Mary Ryan purchased a fixed-rate mortgage on May 1st, 1996, from the following institutions and wished to switch to a variable rate contract on May 1st, 1999, how and what would they be charged in general terms?
The current outstanding balance on the Ryans' mortgage is £80,000 and they have two years remaining on their fixed-term contract. Although some lenders have changed the way they calculate "break fees" since John and Mary took out their contract, the old formula applies in the Ryans' case.
AIB would use the following formula to determine the Ryans' break fee. The outstanding balance multiplied by the difference in the interest rates multiplied by the residual time period. However, the bank gives credit, or decreases the break fee amount, for the reducing balance. In addition to the fee, the Ryans may be subject to a £50 administration charge.
Therefore, if AIB's two-year fixed rate is 5 per cent now and was 8.5 on May 1st, 1996, the remaining balance of £80,000 is multiplied by 3.5 per cent which equals approximately £2,800. This is multiplied by the two years remaining to total £5,600. When credit is given for the reducing balance, it reduces the amount by nearly £800 to £4,806.04. An additional fee of £50 may also be charged.
Bank of Ireland's mortgages division uses a formula which makes it impossible for mortgage holders to determine the penalty amount without consulting the bank. It is based on the average outstanding balance over the remaining term of the fixed-rate contract. The unknown quantity in the equation is the difference between the rate the bank paid initially to cover its side of the fixed-rate loan and what it will get for it now. Only the bank knows what it paid originally.
According to a Bank of Ireland spokeswoman, the Ryans would pay a penalty of £6,267 based on £80,000 remaining (from an original mortgage of £85,600). Their payments under this fixed-rate contract would be £740 a month. If they switched to a variable, they would pay £592 per month, a savings of just under £150 a month. However, it would take more than three years to make up the £6,627 assuming interest rates remained low.
At EBS, break fees for fixed-rate contracts are based on the term of the loan. Penalties for breaking one- and two year fixed-rate mortgages equal three months interest. Three-, four- and five-year fixed-rate loans which are terminated incur six months interest and 10-year fixed equal 12 months interest.
In our example, there are two years remaining in a five-year fixed so the Ryans' break fee is six months interest on the outstanding amount of £80,000 which is £3,400. This is determined by multiplying £80,000 by 8.5 per cent rate which equals £6,800 then multiplying this by a half year or 0.5.
The early redemption penalty does not apply if the fixed-rate loan is transferred to a new main residence property.
First Active says its penalty equals six months interest. For the Ryans, this totals £3,353.42. First Active uses the same formula today.
National Irish Bank says the majority of break fees are charged at six months interest at the fixed-rate agreed for the existing term. In less than 5 per cent of cases, a complicated Treasury calculation is used which is significantly more than the six months calculation. In the Ryans' case, NIB calculates on the basis of the six-month rate meaning they would pay a £3,427.95 penalty.
TSB says that if the Ryans took out a new mortgage with it on May 1st, 1996, and after three years wanted to break the contract, they would be charged three months gross interest, which it calculates as £1,676.71.
If the Ryans took out a new mortgage after May 8th, 1997, they would be charged significantly more, since TSB changed its calculation formula on that day. Today, TSB's calculation looks like this: A x B x (C-D) where A is the amount of the loan (re)paid multiplied by B, the balance of the fixed-rate period (expressed in years or part thereof). This amount is then multiplied by the difference between C, the fixed rate applying to the loan at the date of repayment, and D the current fixed loan rate. Under the new formula, the Ryans would pay £5,760.
Ulster Bank charges six months interest on the outstanding balance and calculates this as a £3,400 break fee for the Ryans.
The Ryans achieved the lowest "break fee" with TSB Bank at £1,676.71 and the highest with Bank of Ireland at £6,627. However, those looking for a new mortgage should remember that many banks and building societies have changed their calculation method since the Ryans took out their mortgage in 1996. It is essential to obtain details of break fees and other penalty charges from lenders in writing when taking out a new mortgage.
Individuals like the Ryans, who took out a fixed-interest rate mortgage a number of years ago should ask their lender to calculate the break fee and then determine whether it's possible to win the interest-rate game by switching mortgages despite the various penalty payments incurred. In many cases, it will pay to forego this decision until the end of the existing mortgage's term.
