Loan termination

Many private borrowers feel hesitant at the thought of terminating a loan, as they believe they are in a dependent relationship with their previous lender (e.g. a bank). In fact, it is not unusual to end a loan early.

This early termination is available to both parties in almost all types of contracts, and a loan termination can occur for different reasons. Its form depends on which party terminates and on the type of loan involved.

Termination of a consumer loan by the borrower

In general, a consumer or customer who terminates a loan is obliged to repay the outstanding remaining balance to the lender, such as a bank, within fourteen days after the termination takes effect. If they fail to do so, the termination becomes ineffective retroactively. In addition to this basic condition, various notice periods are provided and possible compensations for the lender or bank may apply due to the early termination.

For a consumer loan in the form of an installment loan with a fixed interest agreement, a borrower can now terminate the loan with the bank at any time due to an EU directive. This termination facilitation has applied to loans since 11 June 2011. If the loan was concluded earlier, termination is associated with a three-month notice period.

For example, a loan with a fixed interest rate that was agreed for only a limited time can be terminated on the day the fixed-interest period ends, subject to a one-month notice period. This is set out in the BGB under § 489 Abs. 1 Nr. 1. According to § 489 Abs. 1 Nr. 2 BGB, it is also possible to terminate a loan with a bank or other credit institution without giving a reason if it has been running for already over 10 years. For a variable interest rate, the borrower can terminate the loan agreement in accordance with the three-month notice period under § 489 Abs. 2 BGB.

The prepayment penalty on loan termination

In addition, the lender may demand a prepayment penalty in the case of early termination. This depends on the agreements made between lender and borrower.

The prepayment penalty is not a statutory mandatory payment. Lenders can waive it when the loan agreement is concluded. If no such agreement exists, a compensation payment of at most 1.0% may be claimed for a remaining contract term of more than one year and 0.5% for a remaining term of under one year. The calculation basis is the outstanding remaining balance. However, this statutory limit does not apply to mortgage loans.

Loan termination for variable-rate loans

If the loan termination concerns a loan with a variable interest rate, compliance with a three-month notice period and repayment of the outstanding balance to the bank are the essential prerequisites. A prepayment penalty is then generally not due, just as for fixed-rate loans that are terminated after the fixed-interest period ends or for loans terminated after a ten-year term with compliance with a six-month notice period.

This facilitation of loan termination is often found in home savings loans (Bauspardarlehen) or extended by higher court case law to special cases such as the sale of a property. Also, the refusal of the previous lender to expand credit and the resulting expected limitations on the economic use of a property give the borrower the right to terminate.

Termination of a consumer loan by the lender

Termination by the lender is subject to much stricter requirements than termination by the borrower. An ordinary termination of a consumer loan usually requires that the contractual parties have agreed that the lender has such a right at all. Only for consumer loans without a fixed term is termination possible at any time.

This typically concerns an overdraft facility on a current account. However, the notice period must be set so that the borrower has sufficient opportunity to arrange a new account connection.

Because it is rarely in the borrower's interest to terminate a loan that is being serviced as agreed, lender-initiated terminations usually focus on loans where there have been contractual breaches or irregularities in the borrower's circumstances.

The lender needs an important reason to terminate the loan. This may be that, despite proper installment payments, the lender or bank has reliable information indicating a significant deterioration in the borrower's financial situation. Such deterioration threatens the repayment in the foreseeable future.

Reasons for loan termination

The most common reason for loan termination is payment performance problems. If the borrower can no longer meet the agreed installments and thus falls into arrears, termination by the lender or the bank is permissible. This corresponds to irregular payment behavior, where payments are repeatedly late (default) or only partial amounts of the agreed installment are paid. In such cases repayment no longer appears possible and a termination by the bank is necessary, allowing it to exercise its right to terminate.

A further important reason for termination is if the previously provided loan securities lose their value or are not provided despite assurances. With the subsequent termination, the outstanding loan amount becomes due in full and usually within a short period. If this amount cannot be settled, guarantors may be called upon, collateral realized, and the claim may be secured by court judgment.

Terminating a loan for the purpose of refinancing

Borrowers who find during the term of a loan that the agreed conditions are no longer up to date often use loan termination to refinance. The outstanding remaining loan is determined and a new financing agreement is arranged with another bank or credit institution (lender).

A borrower-initiated loan termination based on economic considerations and observing the required notice periods is harmless to creditworthiness. It is an early but contract-compliant termination of the loan agreement with the bank.

Before the contract is ended by the loan termination, a precise review of the agreed conditions is advisable. If payments have been undisturbed, the previous lender (the bank) will do everything possible to keep the contract in force.

If the bank is unsuccessful because the borrower's termination is permissible, claims for prepayment compensation can be expected. However, this only applies if such claims are legally provided for in the specific case and then only to the permissible extent.

When loan termination for refinancing makes sense

Terminating a loan for refinancing therefore makes sense whenever the benefits of such a switch in financing have been carefully calculated. Depending on the conditions of the new loan agreement, termination can be economically advantageous even with possible prepayment penalties. For example, the term of the refinanced loan can be shortened due to lower interest rates.

If the shorter term is of secondary importance to the borrower, the monthly burden for the borrower can be reduced.

Many banks offer, as a free service, that after the loan termination the refinancing of previous loans is carried out directly with the disbursement of the new loan. For this purpose the outstanding loans are requested as of a previously agreed cut-off date.

If the loan is disbursed, the lender forwards the exact amounts to the previous lenders. The borrower's effort is then limited to terminating the old loan and servicing the new consolidated loan.