What is a prepayment penalty at a bank?

How is the prepayment penalty calculated?

To understand why the bank charges interest, you need to change your perspective. The bank itself refinanced the money it lent you on the capital market or through savings deposits. It fully expected to receive interest from you for the entire loan term.

loan agreement early due to a prepayment penalty , the bank receives its money back sooner than it would like. It then has to reinvest this money. The problem is: if current market interest rates are lower than the rate in your old contract, the bank incurs a loss. It can only lend the money out again at less favorable terms. This interest rate difference (margin) is what it charges you as a prepayment penalty .

The calculation: A look inside the black box

The amount of the prepayment penalty for a sale is not arbitrary, but mathematically determined. It depends on three factors . Factors depend on:

• Remaining term: The longer the contract would have run, the higher the penalty.
• Remaining debt: The higher the mortgage amount, the more expensive the exit.
• Interest rate differential: The difference between your mortgage interest rate and the bank's current reinvestment rate.

Especially during periods of falling interest rates, prepayment penalties for early mortgage sales skyrocket . If you've taken out a mortgage at 2.5% and the current interest rate is 1.0%, the bank has to calculate the difference of 1.5% over the entire remaining term. With a remaining debt of 800,000 Swiss francs and a 5-year term, this can quickly add up to 60,000 Swiss francs.

Strategies for avoiding prepayment penalties for sales

Do you simply have to accept this "penalty"? Not necessarily. There are ways to avoid or at least reduce the prepayment penalty for selling a loan .

1. Transfer to the new object

Are you planning to buy a new property after selling your current one? Many banks allow you to simply "transfer" your existing mortgage. The property is replaced (mortgage substitution). Since the loan agreement continues, no prepayment penalty is incurred upon sale . The prerequisite is that the new property meets the bank's financing guidelines.

2. Takeover by the buyer

Another elegant solution when dealing with prepayment penalties when selling a property is to transfer the mortgage to the buyer. If your terms are attractive (e.g., an old contract with a low interest rate during a period of high interest rates), this can even be a selling point. The buyer takes over your debt and the contract. However, the bank must agree and check the buyer's creditworthiness. If everyone agrees, the prepayment penalty is completely waived for you.

The tax side: A consolation prize

Should all else fail and you have to pay the prepayment penalty , there is at least some good news regarding taxes. In most cantons (such as Zurich, Bern, or Lucerne), the prepayment penalty is considered an investment cost.

This means you can deduct the prepayment penalty paid on the sale from the profit when calculating the capital gains tax on the property. Here 's an example :

• Profit from sale: CHF 200,000.
• paid on sale : CHF 40,000.
• New taxable profit: CHF 160,000.

This means the state indirectly covers part of the costs. Note: In some cantons or for federal income tax purposes, the prepayment penalty is treated as interest on debt (in the context of income tax). Carefully check which option is more advantageous for you and what your canton allows. Correctly declaring the prepayment penalty can save you real money.

When is it worth quitting despite the penalty?

There are scenarios where selling your property early despite the costs can be worthwhile. For example, if you can sell your property for an absolute top price that might not be achievable in two years, the additional proceeds from the sale could outweigh the cost of the early repayment penalty .

It is a simple arithmetic problem: (Sale profit today) minus (Prepayment penalty for sale) versus (Sale profit in the future) minus (ongoing costs until then) .

Don't be blinded by the amount of the penalty; consider the overall picture. A prepayment penalty for early sale is painful, but sometimes the lesser of two evils compared to lost sales proceeds.

Check the contract carefully

Not every bank demand is set in stone . Sometimes errors creep into the calculation of the prepayment penalty . Was the correct reinvestment rate used? Were special repayment rights taken into account that would have reduced the outstanding debt? It's worthwhile having the prepayment penalty statement reviewed by an independent expert. Especially with very large sums, banks are sometimes willing to negotiate if you point out discrepancies or if you, as a good customer, are keeping your remaining assets with the bank.

Conclusion

Prepayment penalties for selling a property are the downside of fixed-rate mortgages. They protect the bank from lost interest, but burden you as the seller with high one-time costs. Anyone selling a property with an existing mortgage must budget for this expense well in advance.

But you're not powerless. Changing properties or transferring ownership to the buyer can often prevent prepayment penalties . And if you do have to pay: consistently take advantage of tax deductions. Proactively planning for prepayment penalties is key to protecting your net proceeds.

If you are looking for support in calculating your potential costs or need help negotiating with banks, Loft offers transparent and efficient solutions.

Glossary

• Prepayment penalty: A compensation payment to the bank if a fixed-rate mortgage is terminated before the end of the agreed term (e.g., in the case of a prepayment penalty for a sale ).
• Fixed interest rate period: The period for which the interest rate is fixed. Early termination during this period triggers a penalty payment.
• Reinvestment yield: The interest rate at which the bank can reinvest the prematurely repaid money in the capital market. The difference for the Contract interest rate determines the amount of compensation .
• Mortgage substitution: The exchange of the security (real estate) in the mortgage agreement. This makes it possible to transfer the mortgage to a new house and avoid the prepayment penalty upon sale .
• Capital gains tax on real estate: Tax on the profit from the sale. In many cantons, the prepayment penalty for the sale is deductible as an expense.