A breakage cost is a penalty that borrowers must pay to lenders for violating the terms of a fixed loan agreement by paying off the debt before the due date. Banks determine the cost by calculating the total value of interest payments on the fixed loan during a quarter. The borrower inherits the risk when purchasing a fixed loan, and the terms of the agreement must describe these factors.
When a certain loan product is issued by a financial institution, there is an interest rate linked to the payment of the debt. Often these interest payments are included in the budgets and other financial plans of the lender. In the event that a borrower repays a lender for debt structured as a fixed loan early, a cost of breakage will generally be assessed. This is the penalty that the borrower must pay to the lender for violating the terms of the agreement and paying the debt before the due date. Breakage cost may also refer to an amount paid by a supplier of products to a customer to cover damage that may occur to items, such as inventory, during transportation.
When applying for a loan, such as a home mortgage, it is possible to obtain a fixed interest rate. With this type of loan, a borrower knows precisely how much the monthly payments will be. To make the loan possible, a lender may need to borrow capital from the financial markets to obtain the fixed interest rate. If a borrower decides to refinance a loan or pay off debt early, the lender will likely be charged a breakage fee for failing to meet the terms of that agreement. Those charges are later passed on to the borrower.
Banks adhere to some formula for issuing a breakage fee. This cost can be assessed by determining the total value of interest payments on the fixed loan during a quarter. If you are refinancing, the break cost can be determined by calculating the difference between the interest owed on both loans. The bank is likely to charge the higher of the two possible scenarios, if applicable.
The risk is inherited by the borrower when they purchase a fixed loan, and these factors must be described in the terms of an agreement when the fixed loan is issued. A financial institution may have a policy to issue a break charge to a customer for breaking an agreement based on all the interest that would have been paid if the loan were not paid off early. As a result, the lender does not lose money and the borrower remains responsible for the original terms, even with an early repayment. A lender may insist that its other financial commitments must be honored despite the borrower’s changed circumstances.
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