Importance of the Early Repayment Decision
In principle, a distinction must be made between the early repayment compensation, abbreviated VFE, and the non-acceptance compensation. The former is payable when a borrower terminates their contract during a fixed interest period and repays the loan amount prematurely.
The term non-acceptance compensation is used when the borrower dissolves their loan agreement before the loan amount has been disbursed to them. A further distinction must be made between compensation for early repayment and a claim for damages on the part of the lender.
Compensation by the customer becomes due when the borrower has decided on early repayment. If the loan agreement was terminated by the bank because the borrower did not fulfill their contractual obligations, the bank can claim damages from them. These are calculated on the same basis as the compensation for early repayment.
When can a loan be terminated without these costs?
If a loan has a variable interest rate, the customer can decide on early repayment without the risk of a claim for early repayment compensation whenever the interest rate is changed by the bank. Deviating arrangements with the exclusion of early termination for an initial period of three months are possible.
For consumer loans, it is also common to grant the customer the right to repay the loan early at any time without additional costs, even if here the interest fixation period extends over the entire term of a loan. Further special regulations have been created by the legislator for loans where the fixation of interest covers a period of more than ten years.
If ten years of the term have been completed for these loans, the customer can decide on early repayment without risking a claim for compensation by the bank. The ten-year period begins on the day the borrower received the full loan amount. Under this special regulation, the borrower must observe a notice period of six months.
Early Repayment Decision with Interim Repayments
If someone wants to keep the option of early repayment without compensating the bank at certain times, loan agreements in which the lender allows interim repayments are a good choice. It is common practice here that both the permissible dates and the maximum amount of an interim repayment are concretely defined. As a rule, the contracting parties agree either lump-sum amounts or a maximum percentage of the remaining loan balance to be repaid at that time.
One should also be aware that one does not only risk an early repayment compensation when wishing to terminate a loan prematurely.
If a loan is secured by a lien in the land register, the bank can refuse to accept repayment during the period for which the interest is fixed. It should also be noted that, for example, refinancing may entail additional costs in the form of notary and land registry fees for the transfer of the mortgage rights to the new lender.
The Legal Basis and Calculation of the Compensation
The early repayment compensation is effectively a reimbursement for interest income that the lender has lost due to the premature repayment or non-utilization of a loan. In technical terms, this is referred to as loss of interest income (Zinsausfallschaden).
The legal provisions on this are contained in Section 490 of the German Civil Code. This states that compensation is due when the interest rate fixed in the loan agreement is higher than the rate the bank can achieve in a replacement transaction, i.e., the disbursement of the loan amount to another customer. Two different methods can be used to calculate the compensation. The borrower is better off if the active-active method is chosen. It takes into account the loss resulting from the deterioration of interest as well as a margin loss on interest.
The compensation to be paid increases the longer the remaining fixed interest period. From higher court case law, the inclusion of a net interest margin of 0.5 percent has become established, which must, however, still be adjusted for the saved administrative costs for the terminated loan term as well as risk costs. Additionally, the bank may claim a fee for processing the loan termination in the event of early termination during the interest fixation period.
Early Repayment Decision – Active-Passive Method
The bank may also charge such a fee under the second method of calculating early repayment compensation, called the active-passive method. This method records cash flows that are matched against the actually achievable yields from mortgage bond transactions. If this results in higher costs for the same returns as from the terminated loan, the difference is claimed as compensation. However, following a Federal Court of Justice (BGH) ruling from 2004, PEX yields may no longer be used in this calculation, as they could lead to an excessive compensation amount.
The Early Repayment Decision for Building Savings Contracts
If the bank terminates a loan agreement because contractual obligations were not fulfilled, a loss theoretically arises that is identical to that of a termination by the borrower. Therefore, until now the same compensation could be claimed. However, the Federal Court of Justice's case law on this has changed. The federal judges are of the view that it is not justified for banks to make additional profits from customers' hardships.
For this reason, Section 497 of the German Civil Code is now interpreted in such a way that banks may only charge default interest. Exceptions arise only if additional damage, for example due to refinancing costs, can be conclusively demonstrated.
Special rules apply to building savings loans. In this case, the bank cannot charge compensation for lost interest in the event of early termination of a loan. However, this regulation does not arise from federal law, but from the Common Bauspar Conditions drafted by the banks.
Building savings loans can be terminated at any time. No notice periods need to be observed. Partial terminations through interim repayments are also available to the borrower at any time and in any amount. The reason for this practice is that building societies operate according to the principle of communal saving, and an early repayment by one customer gives them the opportunity to shorten the waiting times for other customers once they reach allocation maturity.
Early Repayment Decision for Consumer Loans
Further special regulations have been created for consumer loans. If the individual loan agreement does not contain a clause on flexible repayment, the bank may, in the event of termination with more than one year of remaining term, only charge a flat compensation of one percent of the outstanding debt.
If the remaining term of the consumer loan is less than one year, the compensation demanded may be at most half a percent of the outstanding loan amount. This regulation follows from the content of Section 502 of the German Civil Code, but is complemented by most banks in the general contractual terms for consumer loans.