If a current loan with fixed interest rate fixation, for example a mortgage lending loan, is to be repaid prematurely, then this is usually only possible against payment of a so-called “prepayment penalty”. But what is meant by the term “prepayment penalty”? How are the compensation payments to the bank calculated and in which situations do they arise? The following article deals with the topic “Prepayment Compensation for Early Loan Repayment” and contains not only general information but also numerous tips and tricks for borrowers.
What is meant by the term “prepayment penalty”?
The term “prepayment penalty” is understood in the banking jargon a kind of “compensation payment”, which is always incurred when a borrower wants to repay a loan with a fixed maturity or borrowing rate prematurely. The background to the prepayment penalty payment is the fact that the Bank has taken into account certain interest income as part of the lending process and may have priced it into the interest rate. If there is a premature and at least from the bank’s perspective unplanned repayment, so part of the planned interest income accounts. To this end, the bank receives the lent capital much earlier and must lend or invest it at current market conditions. To compensate for the financial disadvantage, banks calculate a prepayment penalty at the respective repayment date, whereby it differs from bank to bank, which formula is used as a basis for calculation.
The Bank can compare the loan amount received too soon and the respective interest rate either with the money market interest rate (asset against liability) or the loan interest rate (asset against asset). In the current period of low interest rates, it would be advantageous for borrowers, some of whom would like to repay old loans with terms above the 4.00% limit, if the bank were to compare active and active.
In practice, however, banks are more likely to compare the interest rate of the old loan agreement with the current level of interest on savings accounts and overnight money accounts, especially since a one-time processing fee normally also accrues for the calculation of the prepayment penalty.
In these situations, banks charge prepayment penalties
When repaying a loan early, banks always charge prepayment penalties if the loan agreement has a fixed term or fixed interest rate. This is usually the case especially for mortgage loans, although there are also some 0.00% financing, which can be repaid prematurely only against payment of a prepayment penalty. While this may sound somewhat paradoxical at first, it simply depends on the fact that processing an early repayment provides accounting effort that is not planned as part of a 0.00% funding. Even if it is not about the repayment of the entire remaining debt, but only a higher one-time payment, banks can demand the payment of a prepayment penalty.
This applies to all special repayments which, in terms of their amount, are higher than the special repayment right stipulated in the loan agreement. Basically, there are no fixed rules for a later repayment against prepayment in standard loan agreements. Whether and to what extent the bank demands a prepayment penalty can therefore always be decided on an individual basis. This is mainly due to the fact that the borrower does not have a legal right to early repayment for standard loan agreements.
Are there early repayments where the bank waives compensation?
According to the saying “exceptions confirm the rule”, there are of course also on the subject of “prepayment penalty” situations in which banks act differently and are quite willing to waive the full prepayment penalty or at least part of the calculated amount. For this, however, a goodwill decision is always required, which is taken by the bank, for example, in the death of the borrower (for example, to accommodate the heirs of the borrower). In addition, in the event of death, a credit institution may waive the early repayment penalty if a term life insurance has been taken out in advance at the in-house insurance company. Another goodwill case can be the divorce of two married borrowers, with such decisions varying from bank to bank.
Tips and tricks around the topic “prepayment penalty”
Anyone who plans an early loan repayment and knows that the participating bank will demand the payment of a prepayment penalty under “normal circumstances”, should immediately seek personal contact with the respective bank. Experience shows that it is extremely useful for the amount of prepayment penalty, if from the beginning with honest and “open cards” is played. A very good relationship of trust or a long-standing and always active customer relationship is also a reason for many banks to meet borrowers in the area of prepayment penalties.
Of course, some negotiation skills are an advantage in these situations, and one has to be careful that the chosen phrasing does not seem too demanding on the respective bank adviser. Numerous consultants feel quickly pressured and thereby lose interest in a customer-friendly goodwill decision. Signals for this are standard phrases such as “Unfortunately, I can not do anything about the amount of the prepayment penalty” or “This is the in-house approach of our bank”, because in practice, mortgage advisers can make a 100% application for grace or a reduced prepayment penalty. It is therefore only a matter of desire or willingness to be good.
Conclusion: The so-called “prepayment penalty” is a kind of compensation payment, which always accrues when the bank receives the remaining debt of a credit agreement, which actually has a fixed term or fixed rate prematurely, prematurely. The background to this is the fact that the bank has calculated in the course of the contract period with fixed interest income, which may also have been decisive for the loan commitment.
As a result of the early repayment, the bank loses at least part of this calculated interest income, which is why, apart from certain goodwill cases (different from bank to bank), the payment of a prepayment penalty is always required. In order to keep the amount of the compensation as low as possible, an open exchange with the respective bank should take place from the beginning.