Understanding your home loan exit fee

More than 80 percent of home loan contracts stipulate an exit fee. This fee should not be confused with break costs associated with fixed-rate loans.

Unfortunately there is logic to these fees. You lock in at, say, 7 percent for three years but the current market rate is much lower so you naturally want out. Break fees represent the loss to the lender if you break your contract with them.

As for exit fees, which weren't even around five or six years ago, they're just plain stupid because they're charged on variable rate loans simply because you either want to refinance or pay out your loan within the first five years.

A report on exit fees by the Australian Securities and Investments Commission (ASIC) found that Aussies pay nearly five times more to switch their lender than home owners in the US and Britain. That same report identified that while the average early termination fees sat around the $1000 mark, some exit fees were as high as $5685 on a $250,000 variable rate loan.

Variable loan exit penalties come in several forms: a fixed dollar amount, a specified number of monthly repayments, or a percentage of the original loan amount.

Let's say your mortgage contract stipulates a percentage-based penalty. If you originally borrowed $500,000, easy in Sydney or Melbourne, you'd be up for a $5000 goodbye fee based on a 1 percent penalty.

Fair? Hardly, which is why Money reader John McCarthy is keen to find out whether or not what he read was true.

"I read in an article that the government was going to legislate that when you change mortgages to another bank they could only charge you a fee proportionate to the work involved rather than a set fee. I think it was expected to start from July 1, 2010."

Well the good news John is you've got the date right. July 1 was D-day for unfair bank fees.

Under new laws, which apply to a whole range of industries, consumers will have some additional rights regarding unfair terms. It's a joint enforcement of the law by the Australian Competition and Consumer Commission (ACCC) and state and territory fair trading or consumer affairs offices.

For home owners, that now means they can question their lenders on whether or not early termination fees are deemed to be fair.

Banking and financial services ombudsman Philip Field says a fee of a few hundred dollars is probably reasonable. But asked about percentage-based fees that amount to thousands of dollars, he says: "We are looking at those. There's an issue there about whether it represents your administrative costs if it's based on a percentage. Each case needs to be assessed on its merits."

Given the new consumer laws only apply to contracts entered into or varied on or after July 1, 2010, I doubt whether John could rely on it. But all is not lost! John's home state of Victoria has had, for some time, legislation that protects consumers from unfair terms in consumer contracts.

For the rest of us, there's the Uniform Consumer Credit Code, which says exit fees must not exceed a reasonable estimate of loss arising from the early termination.

If you believe your contract is unfair you can take it up either through alternative dispute resolution mechanisms or through action that you may take in a court of law, or ASIC may take action.

I personally am keen to hear of any home owner who has been successful in proving that an exit fee was unfair. While this new legislation looks good on paper, it is very unclear how it will work.

For home owners about to settle on a new mortgage, the best advice here is to ask your lender what exit fees apply so as to avoid any hiccups down the track. The fact is, many home owners do terminate or refinance their loan within three years so the likelihood of being slapped with a penalty fee is very real. ASIC's report into exit fees found that on average non-ADI (authorised deposit-taking institution) lenders charge the highest early termination fees, followed by large banks.

Bells should ring if you're being offered a low-interest rate home loan coupled with a low set-up fee because the sting is usually a hefty exit fee.

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