A prepayment penalty is a fee payable by a borrower to the bank if the loan is repaid early, i.e. before the agreed end date. It serves to compensate the bank for the lost interest income that results from the early repayment of the loan. However, there are ways to recover or prevent the payment of the prepayment penalty. Prepayment penalties that have already been paid can also be reclaimed under certain conditions.
Loans: An indispensable tool to make dreams come true
A loan can be essential for many people in many situations. Be it to compensate for higher expenses that have arisen at short notice, such as repairs, or to realize certain lifelong dreams, such as the dream of owning your own four walls. The reason for the loan is always the same: there is a lack of equity. The loan provides the capital to implement the project, but it is only borrowed. However, if the person has capital at a later date and wants to repay the loan prematurely, the so-called prepayment penalty must always be taken into account.
The bank gets more money than just the remaining debt
As with so many things in life, the devil is often in the details when it comes to a loan agreement. Although the basic principle of a loan is relatively simple, the aspects of the term and interest often complicate this basic principle considerably. Although the borrower repays the monthly amount agreed in the contract and in this way gradually reduces the remaining debt to the bank, the general terms and conditions of the contract are only rarely read by the borrowers in advance. The so-called early repayment penalty can also be found in the same general terms and conditions of the loan agreement.
As the name suggests, this prepayment penalty is compensation paid by the borrower to the lending bank. This compensation payment is due if the borrower unexpectedly has the capital to fully repay the loan amount during the loan agreement period. Many people then make the mistake of only looking at the remaining debt, which they would like to transfer to the bank to replace the loan.
If a prepayment penalty is agreed in the loan agreement, that amount must be transferred to the bank in addition to the outstanding balance.
In view of this, there is a prepayment penalty
If a loan agreement is agreed between a lender and a borrower, this agreement always has a certain term. In connection with the interest, this results in a profit situation for the bank, since the interest is added to the loan amount. However, the bank can only generate this profit if the borrower complies with the contract over the entire term. If the borrower decides to terminate the loan early by making a one-time payment of the remaining debt, the bank will lose interest for the remaining term of the loan agreement. In order to compensate for this loss by the bank, there is ultimately the prepayment penalty.
The bank may not charge any fees for determining the prepayment penalty
Basically, it is relatively easy to calculate the amount of the prepayment penalty. In current practice, the prepayment penalty is 1 percent of the remaining debt. However, according to Section 502 (1) of the German Civil Code (BGB), the bank is entitled to “reasonable” compensation in the event that the loan is repaid early. In many cases, it is therefore not easy for the borrower to determine the amount of the prepayment penalty independently. That is why many borrowers ultimately turn to the lender with a request to determine the exact amount. Some banks ultimately charge fees for this measure, but this is not legally permissible. In its judgment of December 14, 2022 (file number 17 U 132/21), the Frankfurt Higher Regional Court (OLG) stated that determining the prepayment penalty is expressly considered to be a secondary obligation of the bank to inform the customer and that the bank may not charge any fees for this.
Is the bank always entitled to the prepayment penalty?
There are cases in which the legislature excludes the bank’s claim to the prepayment penalty from the outset. If a consumer loan was entered into between the Borrower and the Lender after March 21, 2016 and such consumer loan includes a fixed interest rate over a period of 10 years, the Borrower, in its capacity as a consumer, after the expiration of the “ten-year Deadline” terminate the consumer credit within six months without paying any compensation.
According to Section 489 (1) No. 2 BGB, the start of the “ten-year period” is set on the day on which the bank has paid the loan in full to the borrower.
When the bank terminates the loan
If the bank terminates the loan to the borrower, the bank is not entitled to the prepayment penalty. However, if unpaid installments are the reason for termination, the bank may charge the borrower interest on arrears.
If the contract is defective, this has an impact on the prepayment penalty
It is always advisable for borrowers to take a close look at the loan agreement. However, this view can be doubly rewarding, especially when it comes to the bank’s claim for a prepayment penalty. The reason for this lies in the fact that the bank’s claim to the prepayment penalty is excluded if the contract is defective. These errors relate to the information in connection with the contract period or the borrower’s rights of termination.
Even if the calculation of the prepayment penalty must be considered insufficient, the bank’s claim to this payment is excluded. However, this is only limited to consumer contracts that were agreed between the borrower and the lender after March 21, 2016.
The BGH has already spoken on this subject
It is striking that the term “insufficient” is often used in connection with contracts. This of course raises the question of when exactly that circumstance “insufficient” is to be regarded as given. The pure designation “inadequate” is quite vague and assumes that the status “adequate” is known. However, this is where the real problems of the past begin, as there were too often disputes between the borrower and the lender in this regard. In view of this, the Federal Court of Justice has already dealt with the issue and passed a judgment.
BGH: Lender must name significant parameters for prepayment penalties in a comprehensible manner
On November 5, 2019, the BGH determined that a lender in connection with the calculation of the prepayment penalty must clearly specify those parameters to the borrower that are to be regarded as significant. The judgment (file number XI ZR 650/18) was pronounced as a consequence of a case involving a car loan. The borrower wanted to repay this car loan early and was confronted with a prepayment penalty from the lending bank. The borrower was unable to understand the amount of the early repayment penalty, so the case ultimately ended up before the Federal Court of Justice, where the final decision was made.
Borrowers need to know their rights in relation to the prepayment penalty
The prepayment penalty can be a significant amount that most borrowers cannot understand at all in this form or that borrowers often do not focus on. It is therefore particularly important for the borrower to know the exact background and their own rights and obligations in this context. There is no doubt that the bank is entitled to a prepayment penalty for certain loan agreements, such as construction financing. Only the amount must be presented in a comprehensible way for the borrower at any time so that legal disputes can be avoided.
Avoid or recover prepayment penalties
In some cases, the prepayment penalty can be avoided or even reclaimed if the information provided by the bank to calculate the penalty is incorrect or incomplete. Since March 21, 2016, the day on which the Mortgage Credit Directive was implemented, banks must correctly inform customers of mortgage lending about the term of the contract, the right of termination and the calculation of the prepayment penalty. If, for example, the bank provides insufficient information to calculate the compensation, all entitlement to this fee is excluded under the law. In this context, mistakes are often made, such as the incorrect presentation of the calculation period, the non-consideration of special repayment rights, incorrect information on termination rights and the use of low yields on Pfandbriefe to determine the prepayment penalty. If necessary, we will be happy to check your loan agreement with regard to the points mentioned.
Conclusion
In many cases, an installment loan or car loan can be redeemed early in order to save interest for the remaining term of the loan. This can prove advantageous in certain situations, as it means that the borrower has to pay less money back to the bank overall. However, there is also a downside to the coin: In this case, the bank receives compensation, the so-called prepayment penalty. The prepayment penalty is a fee the bank receives for the loss of future interest due to the borrower repaying the loan early. However, this fee is manageable and usually amounts to a maximum of 1 percent of the remaining debt. In other words, if the borrower has, say, a $10,000 loan and redeems it early, the prepayment penalty would be a maximum of $100. Whether it is worth repaying the loan early depends on the individual circumstances. Borrowers should always compare the prepayment penalty and the remaining interest beforehand to find out whether it is worth repaying the loan early. It is also advisable to consult a financial advisor in order to make an informed decision.
