All lenders will charge some penalty for mortgage holders seeking to break out of a fixed-interest rate contract before the agreed term expires.

But some penalties are far more severe than others and borrowers need to do their sums to see if they can save money.

Recent reductions in fixed interest rates on residential mortgages and expected falls in variable interest rates in the coming months have prompted fears among mortgage holders with either long-term fixed-interest rate mortgages or older fixed-rate mortgages that they may lose heavily.

Generally, the longer the period remaining on a fixed-term mortgage at a relatively high interest rate the more likely the customer will be able to save by breaking that contract and moving onto a variable rate or a new fixed-rate product.

But if the contract has only a short period to go the penalties will generally outweigh the benefits of a move to a lower interest rate.

Whether a borrower should go for a fixed or a variable-rate mortgage will depend on particular circumstances and on the expected direction of future interest rates.

An important consideration is the need for security - fixed rates tend to suit borrowers who can just afford their loan at the rate quoted but who would be in trouble if rates fluctuated upwards, and, borrowers who want to know the exact amount of monthly repayments.

The rates offered on fixed-rate mortgages tend to be higher than those available for variable products. In effect borrowers pay extra for security - one lender described it as "a sort of insurance premium that their repayments won't rise".

But over the fixed term a borrower can win or lose depending on the fluctuations in variable interest rates.

When variable interest rates increase and move above fixed rates, the fixed-rate mortgage holder will pay less than a variable-rate mortgage holder. But when variable rates fall, the borrower on a fixed-rate mortgage pays more.

How much the fixed-rate mortgage holder wins or loses over the entire fixed term will depend on the fluctuations in interest rates over that period.

At the moment, as a result of the recent reductions, some fixed rates are lower than those available on variable mortgages. This is unusual and lenders say it is a clear signal that markets are expecting interest rates to fall, a move which would bring down variable mortgage rates.

One lender explains why fixed rates tend to be higher than variable rates and why lenders charge a penalty for breaking the contract.

"It's a two-sided contract. For every fixed-rate mortgage we lend we arrange matching fixed-rate funding - generally fixed-rate deposits from customers or money raised on the market. And when depositors or investors agree to lock in their money for a long period they look for better rates than those paid on short-term deposits. We are then locked in to paying the depositors the agreed interest for the period."

Another lender says customers look for fixed rates to protect themselves against the risk that rates could rise. "Put it like this, no one would be looking to break the contract if the rates were moving the other way," he says.

But because mortgages are such a significant commitment, borrowers need to be alert to protect their own interests. They should do their sums to see if they would be better off breaking a fixed-term contract.

There are a number of factors to consider: the penalties their lender will impose; the period remaining of the fixed term; how much higher their fixed rate is compared to variable or fixed rates now offered; the outstanding balance on their mortgage.

Mortgage holders who entered fixed-rate agreements with Bank of Ireland pre-1993 may be able to opt out without significant charge because of the wording of the contract.

Bank of Ireland normally operates a formula whereby a borrower will be charged the greater of three months interest or "the amount calculated by the bank of all losses, costs and expenses arising from such early repayment". This makes it impossible for the customer to calculate the penalty or to assess a penalty quoted by the bank.

A number of institutions charge a stiff penalty of six months' interest on the outstanding mortgage balance. For example, the penalty on a mortgage at a fixed rate of 8 per cent with £70,000 outstanding and one year of the fixed term left would be £2,800. Among the lenders using this formula are the First National and Irish Nationwide building societies.

This interest penalty is fairly crude because it does not take into account the length of time remaining in the fixed term. Borrowers with only six months left will face the same penalty as borrowers with four, five or nine years left. But at least the penalty is transparent and can be easily understood by the customer.

Some lenders charge less than six months' interest. EBS for example varies the penalty depending on the length of the fixed-term mortgage. There is a three months' interest penalty for early repayment of one or twoyear fixed-rate mortgages, a six months' interest penalty on three, four or five-year mortgages and a 12 months' interest penalty on 10-year fixed contracts.

EBS says its penalties do not fully cover the costs incurred in "unwinding" the matching lending/funding arrangements but they are enough to act as a disincentive to customers when interest rates fluctuate.

Some lenders have abandoned the "months' interest" formula for more complicated formulae which they say are fairer to the customer. Unfortunately, they are very complicated making it difficult to assess value for the borrower.

At TSB the early redemption penalty is based on the amount of the loan to be repaid (a), the balance of the fixed-rate period (b), the fixed rate on the loan (c), and the fixed rate that the bank would make on a loan equal to the balance to be repaid for the period remaining in the customers fixed rate loan (d). The formula is a x b x (c - d).

Breaking a fixed-rate TSB mortgage with an outstanding balance of £70,000, a fixed rate of 8 per cent and one year left in the fixed term would involve a penalty of £1,050. A TSB spokesman says the formula favours borrowers with shorter periods remaining in their fixed term.

At Irish Permanent the penalty for early repayment is the lower of 50 per cent of the amount of interest that would have been paid in the remaining period of the fixed term, or, the difference between the interest the bank would earn over the fixed term remaining of the fixed mortgage and the interest the bank would get by investing the balance owed in a Government bond for the remaining period of the fixed-rate mortgage.

On a £70,000 mortgage at a rate of 8 per cent with one year left in the fixed term, Irish Permanent said the penalty charge would be £2,100.

At AIB there is a £50 penalty fee for early redemption plus a formula based on the interest cost to the bank of the contract being broken. The cost of breaking a mortgage contract with a fixed rate of 8 per cent, an outstanding balance of £70,000 and one year left to run would be £860.

A spokesman points out that mortgage holders should weigh up carefully whether it is worthwhile to break the contract and take into account the costs of moving to a different lender if that is what is being considered. Even with the penalties, it might make sense to break a contract when cash flow is the problem.

A borrower could add the penalties to the capital borrowed and move to a lower variable rate. Thus, the borrower could reduce monthly repayments though this would be at the expense of adding a year or more to the term of the mortgage.

For borrowers on longer term fixed-rate mortgages taken out around the time of the currency crisis at rates of 12 to 14 per cent for terms of five to 10 years, the penalties for exiting could be very high. With the drop in market interest rates, the formula method will give a high figure for interest foregone by the financial institution. But at the new lower interest rates, a borrower may just be better off making the move.