Reasons for loan redemption
Many households in Germany have several loans they have to repay. It is not uncommon to buy large and small items on installments. Mobile phone contracts can often generate substantial costs when monthly installments become due.
Ordering from mail-order retailers is easy, also on installments. Amount after amount can add up, which can lead to various loans running in parallel and on different terms. In many cases a costly and necessary purchase or repair is added that can no longer be paid. The spiral of the debt trap begins to turn. At the latest now the customer should consider loan redemption.
With loan redemption, existing loans can be consolidated into a single larger loan. This process of paying off a loan is also called debt consolidation. In many cases this results in better terms and a noticeable improvement in the financial situation. The economic motive for an early loan payoff or debt consolidation varies from customer to customer, but includes three concrete facts:
- Improvement of the loan interest rate and overall interest level
- Achieving better interest rates
- Improvement of the borrower's financial situation
When does loan redemption make sense?
Loan redemption can also achieve a credit increase with provision of cash funds. The definition of loan redemption is to merge the old loans and set up a new contract. With loan redemption the overall interest level is often significantly improved.
Often the old loans were taken out at a time when interest rates were high and that level was fixed for the entire term. Before initiating the termination of ongoing loans, the termination modalities should be checked. Loans with terms over 10 years and a fixed interest rate often have rigid loan and termination rules and cannot infrequently only be replaced at high cost through a prepayment compensation (prepayment penalty). These arise with an early loan repayment, which the bank or lender calculates due to lost interest and the remaining term. Because the missing payments over the remaining term would mean a loss of income for the lender, most credit institutions demand a prepayment penalty. This prepayment compensation regulates the early loan payoff or debt consolidation in the form of a fee. Thus the remaining debt corresponding to the previously planned monthly interest is settled and the credit institution still receives its share of the loan despite early repayment.
After the 10th year and after disbursement of the loan amount, the low agreed interest rates can be included in the contract. This form of lending falls into mortgage lending. After 10 years the loans have a termination notice period of half a year, in which normally no prepayment costs arise.
Pay attention to termination conditions and terms
The prepayment penalty costs can sometimes outweigh the interest advantage achievable through loan redemption, and it can quickly happen that a loan payoff exceeds the planned savings and results in losses for the customer.
Before terminating one or more loan contracts, it should be clarified how the termination conditions including the prepayment compensation are written down. If losses arise for the customer and there is no compelling reason for loan redemption—for example the need to obtain additional cash—one should postpone loan redemption. The main goal of loan redemption is usually to obtain cheaper interest rates and possibly also smaller installments.
Especially during periods when interest rates are at a low point, loan redemption is worthwhile. Then the various contracts can be consolidated at the favorable interest rate that is fixed for the entire term.
New flexible borrowing options
Earlier borrowing was actually inflexible. You took out a loan and paid it off until the end. Interest rates played a subordinate role in this, at least for the "average consumer".
Special repayments, as are often found in loan agreements today, were not provided in earlier loans. With agreed special repayments the installment loan is paid off faster and the customer becomes debt-free.
Today you can refinance or pay off loans. If a year ago you took out a loan with an interest rate of 7% and now you can get the same loan at 4%, the borrower will try to obtain the cheaper installment loan by means of loan redemption. New terms and low interest rates can thus be achieved, which will also be reflected in the monthly budget of a borrower.
Gauge your repayment capacity before loan redemption
Anyone who has loans to repay can apply for loan redemption, whether at their bank or another financial institution. If the borrower wants to combine individual loans at their bank and the bank refuses, there is also the possibility to do this via a private loan broker.
If the terms and income situation have not changed, this is often not a problem. However each bank (and credit institution) has its own framework conditions that on the one hand allow an approval and on the other hand may require a rejection despite the borrower's continued creditworthiness. Before a customer considers redeeming their loans to achieve a better financial situation, they should gauge their repayment capacity. This includes, for example, installment payments, living expenses, reserves for possibly necessary payments and, above all, the status of the current account.
If there are warning signs here, the customer should review their financial situation against realistic possibilities. Only then can a loan redemption and a higher loan amount that includes additional cash make sense.
Considering that the majority of customers cover their wants with installment loans, it is a small step to overindebtedness. Statistics show that about 95% of borrowers repay their loans—and some even before the end of the term due to special repayments—yet about 2% are no longer able to meet their obligations.
If there is the possibility of loan redemption by consolidating multiple loans and their remaining debts at more favorable conditions, this is the first step to getting your personal finances in order. Debts do not appear overnight but develop slowly, often due to unforeseen and steadily increasing expenses.
Compare options before loan redemption
It is advisable in advance to inquire about terms before any financing, for example through comparison portals and directly with the lenders. Loan redemption can help the borrower regain financial independence and again create reserves for important purchases such as a new washing machine, kitchen appliances, a computer or a television.
In addition, there are so-called consumer credit insurances that serve to cover the loan amount, e.g. in case of loan defaults. In general the borrower does not need this insurance. If a bank insists on it, this insurance increases the loan amount, which should be taken into account.
If you are unsure whether loan redemption makes sense in your case, simply contact the MAXDA team free of charge and without obligation!