Loan with Special Repayment

Common guides on choosing a loan often discuss, besides the interest rate, the topic of special repayments. As many banks now offer fee-free special repayments, this is seen as an attractive additional feature in the context of loan granting. But what exactly defines a loan with special repayment? How do special repayments work and what should be considered? This guide looks more closely at special repayments and answers common questions.

What is a loan with special repayment?

A loan with special repayment is usually initially a conventional annuity loan that is repaid in fixed monthly installments. The principal portion increases with each installment while the interest portion correspondingly decreases. This is because borrowers only pay interest on the remaining outstanding balance. A special repayment is an amount that the borrower pays in addition to the regular repayment, thereby significantly reducing the loan principal in one go. Because banks lose interest income this way, they have the right to demand a prepayment penalty for a full or partial early repayment of the loan.

How is the prepayment penalty regulated?

The prepayment penalty is legally codified in §502 BGB. Accordingly, banks generally have the right to charge a reasonable prepayment penalty in the event of early loan repayment. The legislator, however, distinguishes between general consumer loan agreements and mortgage loans with a fixed nominal interest rate and a corresponding fixed interest period:

1. Regulations for general consumer loan agreements
If you conclude a conventional installment loan with a bank, you have the right under §500 para. 2 BGB to repay it in whole or in part at any time. The bank may charge a prepayment penalty, but its amount is precisely specified:\

• Remaining term of the loan under one year: 0.5% of the amount repaid early\
• Remaining term longer than 1 year: 1% of the amount repaid early
  2. Regulations for mortgage loans with a fixed nominal interest rate

****From the code of law no general right can be derived for borrowers to partially or fully repay a mortgage loan before the end of the fixed interest period. The only exceptions are a fixed interest period of more than 10 years (§489 para. 1 no. 2 BGB) and particularly compelling reasons. Otherwise, banks are not obliged to accept an early termination or partial repayment. If they do so as a gesture of goodwill, the borrower must pay a reasonable prepayment penalty, which is not precisely defined by law. Due to the long terms and high loan amounts, it is, however, regularly to be expected that this will be very high.

Fee-free special repayment allows partial repayment without prepayment penalty

A loan with special repayment is usually not only an offer that expressly permits early partial repayment. Often the special repayment is also granted free of charge. There are different models:

Limited fee-free special repayment: This version of fee-free special repayments is very common today. For example, in mortgage financing borrowers are often allowed to make special repayments of up to 5% of the loan amount per year.
Unlimited fee-free special repayment: This form allows the borrower to make special repayments of any amount at any time. Often such an offer also includes the option to fully repay the loan early. 

How do special repayments affect loans?

When a borrower makes a special repayment on their loan, this clearly reduces the outstanding balance. They have repaid part of the borrowed money early and therefore owe the bank less. In addition, a special repayment has further effects.

Effect on the term of a loan

A loan with special repayment can be paid off significantly faster if the option for early partial repayment is used. Banks typically do not reduce the monthly repayment installment after a special repayment, but rather shorten the term of the loan. How much the term is shortened by a special repayment is shown in the following example.

• Loan amount: 15,000 Euro
• Term: 5 years
• Effective annual interest rate: 3.50% p.a.
• Repayment rate: 272.51 Euro

Without the special repayment this loan would be fully repaid after 5 years. However, if the borrower makes a special repayment of 10 percent of the loan amount (1,500 Euro) after the first year, the term is shortened. The special repayment of 1,500 Euro after the first year thus means that the loan is fully repaid after about 4.5 years instead of 5 years. Thus, special repayments shorten the loan term.

Effect on the total cost of a loan

The total cost of a loan describes the loan amount plus the interest costs over the term. To test the effect of a special repayment, the above example is now viewed in terms of its costs. If the loan plus interest is repaid within 5 years, a total sum of 16,349.65 Euro results. Subtracting the loan amount yields interest costs of 1,349.65 Euro over the entire term.

In this case the total amount of 16,141.37 Euro is lower than in the scenario without a special repayment. Subtracting the loan amount of 15,000 Euro leaves total costs of 1,141.37 Euro. By making the special repayment in this example, the borrower was able to save 208.28 Euro in interest costs.
Thus, it can generally be stated that a loan with special repayment gives the borrower the opportunity to become debt-free more quickly and also to save on interest costs.

Should borrowers choose a low regular repayment plus special repayments, or generally a high regular repayment?

Comparing a generally high regular repayment with a lower regular repayment combined with additional special repayments cannot give a definitive answer. It depends on the individual case which of the two options will produce better results.

Income situation: If a borrower has a stable, high and secure income, a higher regular repayment should be chosen. This results in a significantly faster loan repayment and thus keeps interest costs particularly low. If the financial leeway is not that large, lower monthly repayment rates can of course be chosen initially. If income increases or savings can be accumulated, special repayments allow the repayment rate to be increased accordingly.

Life planning:

Is family planning still pending? Are other major expenses anticipated? Answering such questions is particularly important when deciding on the initial repayment rate for a mortgage. A high fixed repayment reduces the borrower’s financial leeway and thus also reduces flexibility. 
Arguments in favor of a fixed, high repayment for mortgage financing are therefore

• Faster debt freedom
• Significantly lower interest costs

In contrast, the following aspects speak more in favor of a loan contract with lower repayment rates and a special repayment option:

• More financial flexibility
• Special repayments can be adjusted up to certain limits to one’s own financial capacity

Advantages and disadvantages of loans with special repayment

What advantages and disadvantages do special repayments have?

Anyone interested in a loan with a special repayment option should of course consider the respective advantages and disadvantages beforehand. In the consumer credit sector, however, there are virtually no disadvantages. Since a certain special repayment option is standard for many installment loans today, it usually does not increase the interest rate. Thus, the only real disadvantage is the early expenditure of a larger sum of money. Fundamentally, special repayments have two main advantages:

• Faster debt freedom
• Lower interest costs

Lower interest costs in particular have a very noticeable effect on loans with very long terms. An example using a mortgage loan illustrates this in more detail. Let’s look at the development of interest costs and the outstanding balance in the case of a special repayment.

In the example the borrower receives a substantial inheritance after one year and can therefore use 5 percent of the loan amount (10,000 Euro) as a special repayment. This results in the following savings for the borrower:

As the example impressively shows, interest costs during the fixed interest period are lower by 4,156.02 Euro at the end if a special repayment of 10,000 Euro is made after the first year. The money could additionally be used to reduce the debt, so that the outstanding balance after 15 years is 14,156.02 Euro lower. For mortgage financing, however, the special repayment option can have an additional disadvantage depending on the contract:

• Renegotiated special repayments usually increase the nominal interest rate

In this context it is important that borrowers carefully consider in advance how high special repayments realistically are for them. If the amount exceeds the standard offer of 5 percent per year, renegotiation may be worthwhile. Prospective borrowers should, however, carefully calculate whether the savings would not be eaten up by the higher nominal interest rate. If the calculation is positive, there is nothing to prevent agreeing on higher special repayments for a mortgage.

For which loans are special repayments possible?

Special repayments are offered today as an additional service for consumer loans and for mortgage financing. However, two different cases must be distinguished. Just because special repayment rights are granted when signing the loan contract does not automatically mean that making a special repayment is sensible for the borrower. Whether the option of special repayments provides a saving always depends on the chosen loan and the negotiated terms.

Which loans are special repayments sensible for?

Not every loan is suitable for using special repayments. For example, this option is completely pointless for an overdraft facility (dispo), since the borrower can repay the entire loan or parts of it at any time anyway. Variable-rate loans likewise do not need fee-free special repayments because a prepayment penalty for such loans is excluded in §502 BGB.

For which loans are special repayments offered?

In practice, fee-free special repayments are most relevant in the context of mortgage financing. The long terms and high loan amounts mean that a special repayment can save a lot of money, as our example above has already shown. In addition, normal installment loans are also often offered today with fee-free special repayments.

Can special repayments be negotiated later for a loan?

****If a borrower notices during the loan term that a sudden influx of money could significantly reduce their loan’s interest costs through special repayments, the first step is to check the loan agreement. But what can be done if the concluded loan does not allow fee-free special repayments? In this case there are two options.

1. Offset special repayment against prepayment penalty

For a consumer loan, special repayment rights are generally always granted. Borrowers can therefore make special repayments at any time. In this context one should calculate before deciding whether the special repayment is worthwhile despite the prepayment penalty. If it is, the costs can at least be reduced to some extent.

2. Renegotiate special repayments

Especially for a mortgage it can make sense to talk to the bank about renegotiating special repayment options. From a purely legal point of view there is nothing to prevent a later permission for special repayments. The question is always whether the bank or lender will respond positively to such a request. And even if special repayments can be renegotiated, borrowers should also consider any fees for changing the contract in their own calculation. Nevertheless, the motto applies here: asking costs nothing!

In general, renegotiating special repayments is possible but often very difficult. Lenders have little interest in early repayment and would have such a special repayment option remunerated by fees in the contract.

Our conclusion on loans with special repayment

A loan with special repayments is no longer a rarity. Banks increasingly offer a fee-free special repayment option both for consumer loans and for mortgage financing. Fundamentally, a special repayment reduces the term of any loan and also lowers the interest costs over the entire term. However, there are still numerous loans and financings today that do not include any special repayment option.

Whether a special repayment option is important for a borrower can only be determined by the circumstances of the individual case. Those who do not receive additional funds and cannot save money will not benefit from it. In general, however, it is worthwhile to save money and to consider making regular additional repayments on a loan with special repayment. Typically, loan interest rates are higher than interest on secure savings. Those who act prudently and weigh the individual options against each other can substantially relieve their own finances through a special repayment option.