Can a break cost be zero?

Yes. If the wholesale rate for the remaining period is at or above the rate when the loan was fixed, the bank has no loss on its funding and in many agreements nothing is payable. A borrower who fixed when rates were low can often leave without charge. An agreement may still carry an administration fee, or a prepayment fee of a different kind, so it is worth asking for a written figure rather than assuming nil.

Why charge a break cost if the bank can lend the money again?

Because it can lend the money again only at today's rates. The bank locked in the wholesale cost for the whole fixed period, and its funding stays in place when the customer leaves. If wholesale rates have fallen, new lending earns less on that funding for the time remaining than the original loan would have. Lending again recovers the margin, which is why many formulas leave the margin out, but it does not recover the gap in the wholesale rate.

Is a break cost the same as an early repayment penalty?

Not in the way it works. A penalty or fee is a set amount or percentage, agreed in advance, whatever the market does. A break cost is calculated on the day, from wholesale rates and the time left, to reflect the bank's funding loss, and it can be nil. Some agreements use the term early repayment charge for either one, so the clause, and whether it refers to a formula or a percentage, is the place to look.

How can a business reduce a break cost?

Mostly through timing and structure. Repay at the end of the fixed period, or for a floating loan at the end of an interest period. Fix only the part of the debt that is expected to stay. Some bank terms allow a limited early repayment each year on fixed money without a charge. And a bank may agree to extend the fixed period and blend the old rate into a new one, which spreads the cost over the new term rather than removing it.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Break Cost: a Worked Example

The cost of undoing a rate the bank has already funded.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-09 · 6 MIN READ

// THE SHORT ANSWER

A break cost answers one question at the moment a borrower wants out of a fixed rate: what is the difference, today, between the wholesale rate the bank locked in and the rate it can lock in now, for the time left? If wholesale rates have fallen, the bank loses on its funding and the borrower pays the loss, usually discounted to today. If they have risen, there is often nothing to pay. So the same loan can cost a large sum to leave one month and nothing a year later, and the figure has to be asked for on the day.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

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PART OF How Banks Price a Business Loan

// 01 — WHY FIXED MONEY COSTS TO UNDO

When a bank agrees a fixed rate, it generally locks in its own cost for the same period, in the wholesale market or through its treasury. The customer's rate is that wholesale rate plus a margin. If the customer later repays, the bank is left holding a position priced for a loan that no longer exists, and it can reinvest the returned money only at today's rate. Where that rate is lower, the shortfall for the time remaining is a real loss, and the break cost moves it to the borrower who chose to leave.

A floating-rate loan has a smaller version of the same problem. A loan priced on a 90-day bill rate, as many New Zealand and Australian facilities are, fixes the base rate for each interest period, so a repayment in the middle of a period can carry a charge for the days left. Sterling loans on compounded SONIA are different: no term rate is set at the start of the period, and the sterling working group recommended that accrued interest be paid with the principal prepaid. With no matched term funding to break, many such agreements leave break costs out, though some keep a charge or an administrative fee instead. The clause in the agreement decides.

// 02 — HOW IT IS WORKED OUT

Rate gap = wholesale rate when fixed − wholesale rate today for the time left

Lost a year = amount repaid × rate gap

Break cost = each year's loss, discounted to today at today's rate

(nil if the gap is zero or negative, in many agreements)

A bank's own formula is more detailed. It works through each scheduled repayment rather than a single balance, because an amortising loan owes less each year, and it adjusts for interest already accrued. Some banks publish the formula; others give only a quote. The wholesale rates are the bank's own estimates for the period, and they exclude the customer margin, on the reasoning that the bank can lend the money again and earn a margin on it. That is common rather than universal: an agreement can add a fee or define the loss differently. Consumer loans carry their own statutory rules in each market. A company's facility generally turns on what its agreement says.

// 03 — THE EXAMPLE

A clay brick manufacturer, constructed for this page like every figure in it, has a US$8.0m loan with no scheduled repayments, fixed for five years at 6.40%: a wholesale rate of 4.40% plus a margin of 2.00%. Two years in, a shareholder offers to repay it. The rate gap and the sums are shown with annual periods to keep them readable, and every rate is the example's.

Wholesale rate today for three years 3.40%

Rate gap 4.40% − 3.40% = 1.00%

Lost a year 8,000,000 × 1.00% = 80,000

Undiscounted, three years 80,000 × 3 = 240,000

Discounted at 3.40% 80,000 × (0.9671 + 0.9353 + 0.9046) = 224,560

Same loan, other days:

Wholesale rate today Gap Lost a year Break cost

3.40% 1.00% 80,000 224,560

3.90% 0.50% 40,000 111,215

4.40% nil nil nil

5.00% −0.60% gain nil to the borrower here

Part repayment from a sale of US$2.0m: 224,560 × 2.0 ÷ 8.0 = 56,140

Floating, repaid 30 days before a 90-day period ends:

Period rate 4.30%, money placed at 3.90%: 8,000,000 × 0.40% × 30 ÷ 365 = 2,630

The cost is the bank's position, not its opinion of the customer. Nothing on the third line is a discount, and nothing on the first is a punishment: the brick maker's loan is the same each time and only the market has moved. On the rise to 5.00% the bank could reinvest at a profit, and many agreements give the borrower nothing for that gain. The floating line shows why a borrower repaying a floating loan picks the last day of the interest period: the difference is small, and it is easily avoided.

// 04 — HOW IT DIFFERS FROM A PREPAYMENT FEE

A prepayment fee is agreed in advance as a percentage or a formula, and protects income the lender expected to earn; it can apply to a floating loan and does not care where rates are. A break cost is not known until the day and reflects the market. A loan can carry both, and they are added together. Another relative is the swap close-out. A borrower that keeps a floating loan and fixes through an interest rate swap has no fixed-rate break cost in the loan, but the swap has a value of its own when it is ended, and the economics are close to the same thing. The difference is where it sits: in the loan contract, or in a separate one with its own documents and counterparty.

DEFINED IN ONE PARAGRAPH → · FIXED OR FLOATING → · PREPAYMENT FEE →

// 05 — WHERE IT DECIDES A FILE

The obvious place is a refinance. A cheaper offer has to be weighed against the cost of leaving, so the figure is requested before anything is signed, and it is asked for again close to the date, because quotes commonly hold for a few days only. Maturity is the cheapest moment to move, since a fixed period that has ended has nothing left to break.

It also arrives when no one chose it. Many agreements charge it on any repayment before the fixed period ends, including a mandatory prepayment from an asset sale or insurance proceeds, and on repayment after default. In a sale or a workout the break cost joins the payout figure and can use up proceeds the borrower thought were spare. A lender reading a fixed-rate structure therefore asks whether the debt will stay in place for the whole fixed term, since any part repaid sooner is the part that can incur the cost.

THE SIX MONTHS BEFORE MATURITY → · PAYOUT FIGURE →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Working Group on Sterling Risk-Free Reference Rates, Best Practice Guide for GBP Loans (February 2021, updated July 2021) — Appendix 2, Prepayments — Recommends that proportional accrued interest be paid when principal on a loan referencing compounded SONIA is prepaid; it does not itself state a break-cost rule — section 01.

// QUESTIONS PEOPLE ASK

Can a break cost be zero?: Yes. If the wholesale rate for the remaining period is at or above the rate when the loan was fixed, the bank has no loss on its funding and in many agreements nothing is payable. A borrower who fixed when rates were low can often leave without charge. An agreement may still carry an administration fee, or a prepayment fee of a different kind, so it is worth asking for a written figure rather than assuming nil.
Why charge a break cost if the bank can lend the money again?: Because it can lend the money again only at today's rates. The bank locked in the wholesale cost for the whole fixed period, and its funding stays in place when the customer leaves. If wholesale rates have fallen, new lending earns less on that funding for the time remaining than the original loan would have. Lending again recovers the margin, which is why many formulas leave the margin out, but it does not recover the gap in the wholesale rate.
Is a break cost the same as an early repayment penalty?: Not in the way it works. A penalty or fee is a set amount or percentage, agreed in advance, whatever the market does. A break cost is calculated on the day, from wholesale rates and the time left, to reflect the bank's funding loss, and it can be nil. Some agreements use the term early repayment charge for either one, so the clause, and whether it refers to a formula or a percentage, is the place to look.
How can a business reduce a break cost?: Mostly through timing and structure. Repay at the end of the fixed period, or for a floating loan at the end of an interest period. Fix only the part of the debt that is expected to stay. Some bank terms allow a limited early repayment each year on fixed money without a charge. And a bank may agree to extend the fixed period and blend the old rate into a new one, which spreads the cost over the new term rather than removing it.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

Treasury analystFunds the bank and manages the interest rate and liquidity risk created by its own balance sheet.
Product managerOwns what the bank sells rather than who it sells to — the design, pricing, terms and lifecycle of a lending, deposit or payments product.
Business relationship managerCarries a book of trading businesses — wins them, keeps them, and is the bank's voice when the answer is no.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE CALL · THE LOAN · PRICE

A borrower wants a five-year fixed rate. The bank funds itself at floating rates.

What has the bank taken on if it simply agrees?

5 MORE ON THE LOAN · PRICE →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHBreak cost What is a break cost on a business loan?