Prepayment: What It Is and How to Calculate It

Paying off a loan or mortgage early is one of the most effective ways to reduce your debt. However, before taking this step, it’s a good idea to consider whether reducing your monthly payment or the loan term is right for you and whether there are any cost-effective alternatives.

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What is early repayment of a mortgage?

Early repayment of a mortgage involves paying off part or all of the outstanding principal before the date agreed upon with the bank.

Types of Early Repayment

There are two main types of prepayment, depending on the scope of the payment.

Partial repayment

You pay a certain amount to reduce the remaining debt, while keeping the term of the mortgage or loan the same.

Full repayment

You pay off the entire outstanding balance, thereby completely terminating the loan agreement.

How does it work?

When you make an early repayment, the financial institution applies that amount in an order governed by law and by the loan agreement itself.

Accrued interest

The interest accrued from the last day of your monthly payment period until the exact date the extra payment is made is deducted.

Early repayment fee

If your contract includes an early repayment fee, the bank deducts this amount.

Reduction of outstanding principal

The remainder of the amount paid goes entirely toward paying down the outstanding balance.

Why does this affect your savings?

When you make an early payment, the money goes directly toward reducing the outstanding principal, triggering a chain reaction that saves you money.

How the French Amortization System Works

During the first few years of the mortgage, most of your monthly payment goes toward paying interest and very little toward reducing the principal.

Higher interest burden during the first few years

By eliminating interest that would have accumulated and compounded over 10, 15, or 20 years, every dollar paid today saves you future interest.

Reduce Payment or Shorten Term

When you make a partial payment, the bank allows you to choose between two options:

Reduce the payment amount

Your monthly payments are recalculated downward, while maintaining the original repayment term. This is useful if you need to reduce your fixed monthly expenses.

Shorter repayment term

You keep the same monthly payment, but shorten the number of years or months of the loan. Mathematically, this option results in greater total savings on interest.

Calculate an early repayment using basic formulas

To calculate the exact figures for an early repayment, use the French amortization formula (the method used by virtually all banks).

Calculate the monthly interest rate

Exclude principal payments

Apply the formula based on your goal

If you choose to reduce the payment (keep the remaining term “n” in months), calculate the value of the new monthly payment “m” using the standard payment formula:

If you choose to shorten the term (keep the same monthly payment “m”), calculate the new number of remaining months “n” using logarithms:

Early repayment fees

Early repayment fees are charges the bank may impose when you repay part or all of a loan before the term ends.

Differences Between Fixed-Rate and Variable-Rate Mortgages

For fixed- or variable-rate mortgages, a prepayment penalty may only be charged if the prepayment results in a demonstrable financial loss for the bank.

Impact of the Contract Date

For consumer loans, the limits are usually different from those for mortgages:

• ‍If more than 1 year remains. It is usually 1.00%.‍
• If less than 1 year remains. It is usually 0.50%.

The fee amount can never exceed the total interest you would have paid had you not made the prepayment.

Early Repayment on a Fixed-Rate Mortgage

The main feature of prepayment on a fixed-rate mortgage is the stability of interest rates and the legal limits applicable to fees for cancellation or prepayment.

Comparison between the contracted interest rate and the expected savings

Since you have a fixed rate, the interest you pay on the principal does not fluctuate with the market (as is the case with the Euribor for variable-rate mortgages). This makes calculating the exact impact straightforward and predictable.

Possible compensation for financial loss

When you make an extra payment or pay off your fixed-rate mortgage in full, the bank may charge you an early repayment fee.

Early Repayment on a Variable-Rate Mortgage

Early repayment on a variable-rate mortgage involves paying off principal ahead of schedule when your monthly payment and interest are tied to a benchmark rate—specifically, the Euribor mortgage rate plus a spread.

Unlike a fixed-rate mortgage, with a variable-rate mortgage, the impact on future savings will fluctuate every time your interest rate is adjusted.

Changes in Expected Savings When Rates Fluctuate

When interest rates fall, fees may be temporarily suspended or eliminated. However, paying down principal when interest rates are high maximizes the financial return on your payment.

Advantages

Paying off a loan or mortgage early (paying down principal ahead of schedule) is one of the most common financial decisions. This is due to the following advantages:

Lower debt

It reduces your leverage, which improves your credit profile with financial institutions for future transactions.

Greater financial peace of mind

The main benefit. By reducing the outstanding principal, future interest is calculated on a lower amount, which lowers the total cost of the loan.

Greater financial peace of mind

Eliminating or reducing debt provides a direct emotional benefit by lightening the burden of fixed monthly obligations.

Disadvantages

Immediate loss of liquidity

Paying off too much principal without maintaining an adequate emergency fund (3 to 6 months’ worth of expenses) can leave you vulnerable to unforeseen events (unemployment, emergencies, repairs).

Fees or penalties

Depending on the contract and applicable law, the lender may charge a fee on the principal paid off.

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When is it a good idea to pay off a mortgage?

Paying off a mortgage early is advisable when your financial circumstances and market conditions make reducing your debt more advantageous than keeping or investing that money.

High interest rate

Paying off your mortgage offers you a tax-free “guaranteed return” equivalent to your loan’s interest rate. If your mortgage is at 3.5%, paying it off is equivalent to investing with a guaranteed return of 3.5%.

Mortgage in its early years

During the first half of the loan term, the largest portion of your monthly payment goes toward interest. Paying down the principal early drastically reduces the remaining principal and maximizes your cumulative interest savings.

Need to reduce monthly expenses

If you anticipate a future reduction in income or are seeking greater family stability, making extra payments to lower your monthly payment will give you more financial breathing room each month.

When Might It Not Be Advisable to Make Extra Payments?

Although paying down a mortgage or loan eliminates debt and saves on interest, it isn’t always the most financially efficient decision.

Lack of an emergency fund

If an unexpected expense arises and you don’t have cash on hand, you’ll have to resort to personal loans or credit cards with much higher interest rates (8%–20%).

Mortgage with a very low interest rate

If you took out a fixed-rate mortgage at historically low rates, it’s more beneficial to invest that capital in low-risk instruments that yield returns higher than the cost of your mortgage.

Investment Alternatives Compatible with Your Risk Profile

If your investment profile tolerates risk and you have a long-term horizon, historically, investing has outperformed the cost of an average mortgage.

Frequently Asked Questions (FAQs)

What is the difference between partial and full repayment?

The main difference lies in the amount of money you repay and whether the loan agreement remains active or is terminated.

Is it better to reduce the monthly payment or the loan term?

Mathematically, shortening the term always saves more money on interest. However, financially and in practice, reducing the monthly payment offers greater flexibility and security in the face of unforeseen events.

Can you make extra payments several times a year?

Yes, you can make prepayments on a loan or mortgage as many times a year as you like. There is no legal requirement limiting you to a single annual payment.

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Conclusion

The best decision isn’t the one that pays off your debt the fastest, but the one that provides you with the greatest long-term stability and returns. Before making an extra payment, make sure you don’t deplete your capital. Domoblock is with you every step of the way.