Living with Mortgage Break Fees

Abstract

Toby Daglish and Nimesh Patel discuss the rationale behind banks charging break-fees to recoup their losses as a result of customers prepaying loans. Next they chart the historical levels of these for New Zealand. Lastly they develop a model which allows for fluctuations both in banks' wholesale rates and also credit spreads. They find that households can achieve economically significant benefits from both following an optimal prepayment strategy contingent on the break fee used by their bank and also by selection of fixed interest rate term and break fee structure.