A loan (Darlehen) is fundamentally a contract that creates obligations. A borrower receives an agreed sum of money from a lender (e.g., a bank) and is committed for a specified period. It is therefore a subcategory of credit.
A loan requires a written contract. In general these are medium- or long-term agreements. With appropriate provisions, which should be clearly formulated in the contract, a loan can be redeemed. This can be done in the form of special repayments or early repayment.

General rules for the loan and the loan agreement

Concluding a loan agreement requires two valid declarations of intent, from the borrower and the lender (usually a bank or another financial institution). The lender can also require securities that must be in place at the time of conclusion. If an interest rate is charged for the loan period, which is usually the case, this is determined in advance. This interest can be set by agreement, according to a price list, or according to statutory provisions.
In addition to interest, other customary banking costs may be charged, such as processing fees or commitment fees. The contract must contain all important facts. These include, among other things, the exact loan amount, the interest rate, other costs, the term, the repayment installments, and the effective annual interest rate, which expresses the total burden per year as a percentage. By fixing all important components in writing, potential disputes can be avoided in advance and clear facts created for both contracting parties.

Repaying a loan early

As a rule, the loan agreement ends at the agreed time. However, there is also the possibility for both parties to terminate the contract early or extraordinarily. Usually this is associated with the payment of a prepayment penalty, which is often already specified in the loan agreement.

Despite such prepayment penalty clauses, there is room for negotiation if you want to redeem a loan. Borrowers who wish to repay a loan early should therefore enter into negotiations with the lender and explain the precise reasons for the early termination of the contract.

Types of loans

The different types of loans generally relate to repayment.

• In a bullet loan (Festdarlehen) the full repayment of the loan is due at the agreed date.

• In an installment loan or consumer loan (Ratendarlehen / Ratenkredit) the interest accrued over the entire term is allocated to the repayment and then paid to the lender in equal instalments (e.g., monthly). This keeps the monthly burden from the loan constant over the term.

• The borrower usually receives a detailed payment schedule in which all interest and repayments are listed precisely. An annuity loan (Annuitätendarlehen) also results in a constant monthly burden for the borrower over the entire term. However, the repayment portion increases and, conversely, the interest portion decreases with each payment of the loan amount.

• Another variant is the repayment loan (Tilgungsdarlehen). In this loan contract the repayment amount does not change, but the interest is continuously calculated on the current loan balance, so that the instalments to be paid are not constant.

• A loan can also be granted as a loan in kind (Sachdarlehen). In this case an item is lent to the borrower for a specified period. The fee agreed for its use must be paid in a lump sum at the end of the term. In addition, the item must be returned to the lender in the same type, quality and quantity.

Repaying an ongoing loan — watch for prepayment penalties

When a loan is concluded between lender and borrower, the possibility should always be considered that the outstanding balance of the loan might be repaid early. If a loan is repaid, it is advisable to carefully check whether it makes sense to repay an ongoing loan by way of a special repayment.

Interest rates, for example, are subject to the market and are difficult to predict over long periods. If a loan was taken out with an interest rate that is significantly higher than the current rate, it can make sense to negotiate with the lender to be able to repay the loan.

However, you should always pay attention to the costs incurred. Prepayment penalties, which generally arise in the case of early termination, must be recalculated for the possible new loan from the bank. This makes it possible to see whether it is cheaper to refinance than to repay the loan.

Repaying a loan and taking out a new loan

Another case when repaying a loan is taking out a new loan. Repaying an old loan and including it in the new loan agreement can make the monthly burden clearer and often minimize the total monthly strain from loans.

If the new loan is to be taken out with the same lender, there is often the possibility that no prepayment penalty will apply when repaying the loan, since completely new contracts are concluded. Nevertheless, it is also advisable here to consider any costs and the new interest rate.

In business it is common to regularly review existing loans and consider whether a loan can be repaid. Such debt restructurings (refinancing) frequently take place to reduce monthly burdens and to take on new capital at lower interest rates in order to remain operational.

In the private sector, refinancing is also only worthwhile if no higher costs arise and the advantages, such as lower monthly instalments, outweigh them. A special case is when the loan has only a short remaining term. If you want to repay a loan that has only a short remaining period, lenders will usually waive a prepayment penalty. This makes it possible to take out a new loan or repay the outstanding loan early without additional costs.

Refinancing can save costs

The loan agreement must contain details such as the loan amount, repayment and the effective annual interest rate. Despite the clearly defined term, it can sometimes make sense to repay a loan early.

A refinancing, for example, that consolidates several obligations into a single loan usually saves costs and gives the person concerned a better overview of their financial situation. Nevertheless, before refinancing a loan agreement you should carefully check which costs arise and at what point you should repay the existing loan.

Processing fees and possible prepayment penalties can cause additional burdens that must be taken into account when refinancing the loan. In the new financing, all incurred costs, which may also include any redemption amounts, are usually incorporated into the new loan sum. This creates an understandable and controllable financial situation for the borrower.