There are lots of reasons for terminating a fixed-rate mortgage: a change in your income situation, unemployment, a new place of work, a divorce or the death of a life partner can prompt people to sell a property. If you find yourself forced to terminate a fixed-rate mortgage early, it can soon become costly.
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Created on 23.02.2024
A prepayment penalty may be incurred if mortgages are terminated early
Terminating a mortgage before the agreed term usually means paying a prepayment penalty, which can be quite high depending on the interest rate.
When are prepayment penalties incurred?
If you terminate a fixed-rate mortgage prematurely, the lender works out the difference between the agreed mortgage interest and the reinvestment rate: in other words, the lender looks at the conditions under which it can invest the repaid mortgage amount on the money or capital market over the remaining term. If this earns less interest, the lender charges you for the loss. This difference in interest is also called loan breakage costs, and the loss amount is referred to as a penalty.
How is the prepayment penalty calculated?
If you’ve taken out a 10-year fixed-rate mortgage at 3 percent and are forced to sell your home after seven years, then you may have to terminate your fixed-rate deal (unless you can transfer it to the property’s buyer).
If your lender has to accept a refinancing interest rate of 1 percent on the capital market over the remaining three-year term, its loss would be 2 percent a year. That’s a total of 24,000 francs on a fixed-rate mortgage of 400,000 francs.
Example calculation
Example calculation for the prepayment penalty if the interest exceeds reinvestment yield.
| Aspect | Amount |
|---|---|
| Aspect Mortgage amount |
Amount CHF 400,000 |
| Aspect Interest rate of fixed-rate mortgage (10 years) |
Amount 3% |
| Aspect Interest rate for reinvestment on the capital market |
Amount 1% |
| Aspect Difference for the lender |
Amount – 2% |
| Aspect Difference for the remaining 3-year term |
Amount – 6% |
| Aspect Compensation for the lender |
Amount CHF 24,000 |
When is early termination worthwhile?
Ending a mortgage early can sometimes be the best option. That’s true if the savings you’d make on the new mortgage outweigh the prepayment penalty. As a general rule: early termination is worthwhile if there’s a difference in interest of over 1.5 percent and the term remaining is over a year.
Terminating a mortgage early – here are the options
There are ways of avoiding a prepayment penalty when terminating a fixed-rate mortgage prematurely:
- You can transfer the current fixed-rate mortgage to the person buying your home. Both the lender and buyer must agree to this. If the buyer could take out a cheaper mortgage deal, you could offer to compensate them for the difference in interest – which means you’d still be better off then paying a prepayment penalty.
- If you’re purchasing a new property at the same time, you could transfer your existing mortgage to your new home. Differences in terms of time and financing between sale and purchase transactions can often prove challenging in this situation.
Questions and answers
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The prepayment penalty is based on the amount of loss the lender incurs over the remaining term of the fixed-rate mortgage. That means it’s as high as the difference between the agreed mortgage interest rate and reinvestment yield on the capital market. Then there are administrative and handling fees on top.
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The loan breakage costs are the loss in interest incurred by the lender as a result of the mortgage being terminated: they are the difference between the agreed mortgage interest and the yield from reinvesting on the capital market.
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In a low interest-rate environment, it may be worth terminating your current mortgage deal despite the penalty payment. That’s true if the savings you’d make on the new mortgage deal outweigh the prepayment penalty. As a general rule: early termination is worthwhile if there’s a difference in interest of over 1.5 percent and the term remaining is over a year. However, you need to work this out exactly.
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A Swiss Federal Supreme Court ruling in 2019 defined the following principles: if you are selling a property, you can add the prepayment penalty to the acquisition costs for the purposes of real estate gains tax. That brings down the taxable gain on the sale – if one is made. If a mortgage is terminated and a new one taken out with the same lender, the prepayment penalty can be deducted from income as debt interest. However, if you terminate your mortgage and take out a new deal with another lender, then it’s classified as loss compensation and isn’t deductible.
