Many homeowners would like to pay off their mortgage on their own home early. The reason for this is that interest rates are significantly lower than they were a few years ago.
Early repayment
An early repayment means that you repay more than the amount specified in the repayment schedule agreed with the bank. In the past, mortgages were often interest-only. In such cases, any amount you repay counts as an early repayment.
Since 2013, it has been a requirement that a mortgage for a home must be repaid on an annuity basis over a minimum of 30 years. Early repayment therefore means that you are repaying the loan faster than the annuity schedule requires.
Penalty interest
However, anyone who repays more than the loan agreement with the bank allows generally pays penalty interest and bank charges. The way in which these interest rates and charges are calculated varies from lender to lender.
Incidentally, many loans do provide for partially exempt from fines early repayment. This may be made annually, for example, up to a maximum of 10% or 20% of the principal, or whatever portion of the principal remains outstanding at any given time.
No more fines
Pursuant to a European directive (Mortgage Credit Directive) banks are no longer permitted to charge penalties for early repayment on new mortgages. That sounds positive, but it does not constitute a ban on penalty interest. The bank may still claim compensation for the (present) value of the interest it has foregone as a result of the early repayment. In addition, the bank may still pass on to its customer the direct costs associated with the early repayment.
A cigar from one’s own box
The lower monthly repayments resulting from early repayment of the mortgage on your own home are therefore, to a large extent, a case of robbing Peter to pay Paul. You do not pay part of the interest monthly, but in a single lump sum in the form of a penalty charge.
So why make early repayments? The main reason is that this reduces your debt, making it much less likely that you will be unable to meet your obligations to the bank. In some cases, making an early repayment will entitle you to a discount on the interest you pay to the bank.
In addition, the very low return on savings and the flat-rate tax on savings and investments (income tax in box 3), which is perceived as relatively high, may be a reason to pay off your loans.
One disadvantage of early repayment is that the amount you repay is then tied up in your home. At the moment, it is generally quite difficult to secure a new (additional) loan from the bank.