Be aware of prepayment penalties for early termination

If the student loan is terminated early, most lenders require a prepayment penalty during the fixed-interest period

When taking out a real estate loan, the borrower should not only look at the current conditions, but likewise at the contract conditions. Thus, in addition to the APR, the initial repayment and the fixed interest rate, other options sometimes play a role, such as a special repayment or an early redemption of the loan. In this context, the early repayment penalty may also be of greater importance.

Early dissolution of the real estate loan can be costly © joyfotoliakid,

Special payments and early redemption of the real estate loan

First of all the repayment of the real estate loan takes place within the monthly agreed upon rates, which contain for example with the annuity loan both interest and the repayment. However, some borrowers would like to make unscheduled repayments during the term of the loan or pay off the loan completely ahead of schedule. In the case it depends on whether a variable-interest real estate loan or a fixed-interest loan was concluded, how the bank with regard to the unscheduled repayment resp. Early redemption behaves.

Fixed interest rate: bank must agree to early redemption

In the course of this article, we will only talk about the early redemption of a real estate loan, as this is usually identical in terms of the circumstances to an interim special payment. In recent years, most borrowers have opted for a so-called fixed-interest loan in the context of real estate financing. This means that the interest rate of the real estate loan is guaranteed for a certain period of time. Banks offer fixed interest rates especially for the following periods:

Such a fixed interest rate is not only binding for the lender, but also for the borrower. This means that you may not easily make special payments in between or redeem the real estate loan completely ahead of time. If you wish to do so, the bank's approval is essential.


Early redemption with variable-rate construction loans no problem

In contrast to the real estate loan with fixed interest rate, early redemption is not a problem with variable-rate construction loans. In this case, the bank is allowed to adjust your loan interest rate from time to time, should there be interest rate changes in the market. For this reason, the bank does not suffer any financial disadvantage in the form of a loss of interest if you make an early redemption of the real estate loan. Therefore, both the interim special payment as well as the early redemption of the construction loan on the part of the bank is not subject to approval, should it be a variable-rate loan.

What costs arise with the early redemption?

With regard to the possible costs that can arise from an early redemption of the real estate loan, a distinction must be made between the types of loan and the individual agreements with the bank. In particular, there are the following constellations:

  • Variable-rate loan: no costs
  • Loan with fixed interest rate: unscheduled repayment or. Early redemption contractually agreed
  • Loan with fixed interest rate: customer must pay early repayment penalty

The most common case is certainly in the field of real estate loans with fixed interest rate that the bank agrees to the early redemption on the one hand. On the other hand, however, the customer must pay an early termination fee. Why it is so, you will learn in the next section of our article.

Note: banks charge a prepayment penalty only for real estate loans with a fixed interest rate, if the early redemption is to be carried out during the current fixed interest rate period. The lender is entitled to do this if the fixed interest rate has not already existed for at least ten years.

Why do banks charge an early repayment penalty??

The fact that lenders charge a prepayment penalty for the early redemption of a real estate loan with a fixed interest rate is not a bad intention, but is actually intended to compensate for an interest loss incurred. Why can such a financial loss occur?

Imagine that six years ago you took out a real estate loan with your bank at an interest rate of 2.95 percent. The fixed interest rate agreed upon at the time was ten years, so the current fixed interest rate would actually run for many years to come. However, you now want to redeem the real estate loan early because you would currently have to pay significantly less interest for a new real estate loan.

From the bank's point of view, this situation, which is positive for you, is quite the opposite. If the lender were to agree to the early redemption without further ado, it would incur an interest loss. This results from the fact that the bank can now no longer lend the capital you have repaid at an interest rate of 2.95 percent, but perhaps only at an interest rate of 1.15 percent. The difference in the amount of 1.80 percent would be a real interest loss that the bank would suffer.

In this example, the financial loss of the credit institution would be calculated as follows:

  • Residual debt: 130.000 euros
  • Remaining term of the fixed interest rate: 4 years
  • Agreed interest rate: 2.95%
  • Market interest rate on new lending of money: 1.15%
  • Interest rate differential: 1.80

Now, if you take this interest rate difference of 1.80 percent on 130.000 euros with a duration of four years, this results in a total interest loss for the bank of around 9.000 euro. To compensate for this shortfall, banks charge an early repayment fee.

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How high is the early repayment penalty??

The banks must adhere to legal requirements, but within certain limits it is left to each credit institution, how high the early repayment penalty and on what basis the calculation is carried out. As a rule, the bank will want to compensate at least the interest loss determined in the previous example by the early redemption fee.

For you as a borrower then the question arises whether it is at all still worthwhile to redeem the real estate loan prematurely and to lock for it a new loan at a more favorable interest rate. You must therefore calculate exactly whether it is still worthwhile, even including the early repayment penalty, to pay off the current loan early and take out a new real estate loan for it.

Tip: before paying off your real estate loan early, be sure to ask your bank how much an early repayment penalty would be. If you do not actually save any interest in the future with the new loan, including the compensation, the redemption of the loan is not worthwhile in most cases.

Early redemption can rarely be agreed

While banks are not infrequently willing to allow the customer to make at least interim special payments even on a real estate loan with fixed interest rates without charging additional costs for them, in practice this is usually not possible for an early redemption. There is hardly a credit institute, which promises already with conclusion of a contract opposite the customer that it may make still during the interest fixed period a premature redemption of the credit free of charge.

Early redemption in home financing rarely agreed in advance © Alexander Limbach,

The only way to avoid having to pay the costs in the form of the prepayment penalty would be either to take out a variable-rate real estate loan or your fixed interest rate has already been running for at least ten years. Namely, then you, as a borrower, have the legal right to terminate the loan without having to pay an early repayment penalty.