There are many complaints about the costs that banks charge when consumers pay off their loans earlier than agreed; the penalty interest. In this article we will discuss the background of these complaints.
If you have a loan, you probably think about paying off early. The shorter the period that you pay interest, the better. But banks are generally not waiting for that.
Agreement about fixed-rate period
When taking out a mortgage, you make an agreement with the bank about the period in which the interest rate that you must pay on the loan remains the same. At the moment, the interest rate for a short period is lower than when you set the interest rate for a long period.
Interim repayments are permitted
With almost every mortgage it is permitted to repay an extra amount annually without having to pay any costs. At most banks you can repay 10% of the amount borrowed per year at no cost.
The bank itself borrowed the money
The money that the bank lends to consumers has also been borrowed by the bank itself. The bank itself also pays interest on this loan. The interest that the bank pays to, for example, savers is lower than the interest that the bank charges to people who take out a mortgage. The bank pays its costs from this margin and this margin determines the level of the bank’s profit.
When a bank lends money for, for example, 20 years, it also borrows money for 20 years. When borrowing this money for 20 years, the bank also makes arrangements with savers about the interest they will receive in the coming 20 years. If all parties adhere to their agreements, then nothing is wrong. But if the consumer repays the mortgage earlier than was agreed, the bank will get back the money that they had lent. Depending on interest rate developments, it may happen that the bank can no longer lend this “extra” money at the interest rate at which the bank itself has borrowed it. At that moment the bank suffers a loss.
If a consumer repays the mortgage earlier than agreed, the bank may charge the costs it incurs as a result thereof. In the past, the banks were free to include in the mortgage conditions how these costs would be calculated. The European Union changed this in 2016. In the case of early repayments that take place after 14 July 2016, banks may not charge more costs than they actually suffer from financial disadvantage. The way in which this disadvantage is calculated must be verifiable for the consumer. Although there are still regular discussions after this adjustment about the correctness of the penalty interest charged, the European Union regulation has considerably improved the position of consumers.
Home Owners Association starts trial process
As indicated, the new regulation applies to early repayments that took place after 14 July 2019 is of the opinion that when determining the amount of the penalty interest on repayments that took place before this date, certain banks were wrong to calculate much too high penalty interest rates. The Home Owners Association has therefore started a trial process against a mortgage provider. Experience with this type of test process shows that the final outcome often takes several years to come.
If you are going to pay off your mortgage early in the coming period, it is in your interest to check the amount of the penalty interest well. Of course we are also alert to this for our clients.