They pointed out that the bank's interest rates had not changed since they fixed their interest rate, so they did not think they should have to pay an early repayment fee. The bank replied that it calculated early repayment fees using the wholesale interest rates available to it, not the retail rates available to customers. Wholesale rates had dropped since they had fixed their rate. Noah and Charlotte did not think this was fair and complained to us.

Our investigation

Under the Credit Contracts and Consumer Finance Act 2003, banks are entitled to charge a fee when a customer makes an early repayment towards a fixed-interest loan. However, the formula used to calculate the fee must be a reasonable estimate of the loss the bank will suffer as a result of the early repayment. We found the bank's formula, which was based on wholesale interest rates available at the time of the repayment, to be a reasonable estimate of its loss.

When a bank agrees to a fixed-interest loan, it usually enters into a “hedging” contract, borrowing funds at a wholesale interest rate. When a customer makes an early repayment, the bank enters into an opposite hedging contract, lending the prepaid funds at a wholesale rate to rebalance its lending portfolio. If wholesale rates have fallen, the bank will suffer a loss because the new contract will be on less favourable terms than the first contract.

Noah and Charlotte argued the bank could take their $250,000 and lend it at the same rate it was charging them, thereby not suffering a loss. We did not accept this argument. Their repayment would not enable the bank to immediately issue a new loan. It could issue loans regardless of whether they made the early repayment, so its return on a new loan was independent of their repayment. The bank’s profit on a new loan could not be treated as offsetting its loss as a result of their early repayment.

Outcome

We did not uphold Noah and Charlotte’s complaint.