Unscheduled repayments: what the payment really achieves and when the money is better placed elsewhere.

How an unscheduled repayment works

An unscheduled repayment is an extra payment on a running loan, on top of the agreed instalment. It is offset in full against the outstanding balance. On an annuity loan this has a double effect: the interest in every future instalment is calculated on a smaller balance, which raises the repayment share at an unchanged instalment, and both effects together shorten the term. The monthly instalment normally stays the same.

In practice it runs like this: you check the allowance and the dates in your contract, notify the bank, many institutions now take the instruction through online banking, and transfer the amount to the loan account. Some contracts allow the payment at any time, others only on fixed dates, for example once per calendar year. If you miss the date, the year's allowance usually lapses; carrying it into the next year is the exception.

After the payment it is worth looking at the new repayment schedule, which you can request from the bank at any time under Section 492 (3) BGB. It shows how the balance and the term have shifted. Our mortgage calculator runs the numbers with your own figures as well.

No right without a clause: how much is allowed

Many borrowers assume unscheduled repayments are a statutory right. On German mortgages they are not. Under Section 500 (2) sentence 2 BGB the borrower of a residential mortgage with a fixed borrowing rate may only settle the debt early during the fixed-interest period with a legitimate interest, such as selling the property, and even then usually against an early repayment penalty. Every penalty-free unscheduled repayment therefore rests on a clause agreed when the contract was signed.

In the offers we see in our brokerage work, an allowance of 5 per cent per year is the standard case, usually at no extra charge. For higher allowances of 10 per cent, or a fully free repayment right, some banks charge a premium on the borrowing rate. Whether that is worth it depends on how realistically you will use the rights: the premium accrues on the whole balance every year, the unscheduled repayment only when money is actually left over.

Three details of the clause decide its value. First, the reference figure: 5 per cent of the original loan amount stays the same over the years, 5 per cent of the current balance shrinks every year. Second, the timing: fixed dates or any time. Third, expiry: unused allowances almost always lapse at year-end. When comparing two offers, these three points belong next to the effective annual rate.

What an unscheduled repayment achieves in numbers

The effect of an unscheduled repayment can be stated precisely, because it needs no forecast: the repaid amount stops accruing interest from the day of payment. The saving equals the borrowing rate on that amount, year after year until the end of the term. The most important rule follows directly: the same payment works harder the earlier it is made and the higher the borrowing rate is. The example uses an assumed borrowing rate of 3.5 per cent and a 2 per cent initial repayment rate, all figures in per cent of the original loan amount.

Assumption: borrowing rate 3.5 per cent over the whole term, 2 per cent initial repayment, monthly instalment, one-off unscheduled repayment of 5 per cent of the loan amount. Own calculation ME Finance, rounded.

The same 5 per cent saves around 7.8 per cent of the loan amount in interest when paid at the end of the first year, and only around 4.4 per cent at the end of the tenth. That is not an argument against late repayments, but it is one against waiting without a reason. The lever becomes even clearer with regular use:

Assumption: borrowing rate 3.5 per cent over the whole term, 2 per cent initial repayment, unscheduled repayment at each year-end in per cent of the original loan amount. Own calculation ME Finance, rounded.

Using the full 5 per cent allowance every year, the loan in this example is cleared after around 12 instead of 29 years, with total interest of around 23 instead of 59 per cent of the loan amount. For most households the row above is the realistic one: just 1 per cent per year, for example from a bonus, shortens the term by around seven years and noticeably lowers the balance at the end of the fixed-interest period, which is exactly the figure that determines the risk of the follow-up financing.

The unused repayment right lowers the early repayment penalty

An unscheduled repayment right has value even if you never use it. That is the point most guides miss. If you repay your loan early, for example when selling the property, you usually owe the bank an early repayment penalty for the lost interest. When calculating it, the bank must treat all future unscheduled repayment rights as if they were used in full. The Federal Court of Justice has declared clauses that exclude this invalid (BGH, judgment of 19 January 2016, XI ZR 388/14).

The mechanics: the penalty compensates the bank's interest loss. That loss is smaller if you would have been allowed to repay part of the loan every year anyway, because the bank would not have received interest on those amounts even without the early settlement. A contract with a 5 per cent annual repayment right therefore leads to a markedly lower penalty than a contract without the clause, all else being equal. How the calculation works in detail and which exclusions Section 502 BGB provides is covered in our guide to the early repayment penalty.

For negotiating a new loan this means: a free unscheduled repayment right is not a perk for diligent savers, it is insurance for anyone whose plans may change. It usually costs nothing and lowers the price of an early exit.

Repay or invest: the honest order of priorities

The unscheduled repayment does not beat the alternative every time. Its effect is a fixed saving at the level of the borrowing rate, and every other use of the money has to be measured against exactly that. Three things come before it in the order of priorities.

• The reserve.Repaid money is bound one-way: it lowers the debt but can only be retrieved through a new loan. An emergency reserve of several months' expenses comes first, especially as an owner with repair risks.
• More expensive debt. If a consumer loan or an overdraft at a higher rate is running alongside, every repayment there saves more than in the mortgage. The most expensive debt first.
• Foreseeable needs. If a renovation or a car purchase is due in two years, the unscheduled repayment is the wrong place for that money. Borrowing it back would cost more than it saves in the loan.

If money is left after that, the real trade-off begins: a fixed saving at the borrowing rate against an investment with an uncertain return. Two mechanics shift the calculation towards the repayment, and both are often overlooked. First, tax: saved loan interest on an owner-occupied home is not investment income and remains tax-free, while investment returns are subject to German withholding tax. Before tax, an investment therefore has to earn noticeably more than the borrowing rate just to draw level. Second, risk: the repayment's saving is fixed, the investment return is not. The reverse also holds: at a very low borrowing rate the fixed saving is small, and on rented property the repayment reduces the loan interest that is deductible as income-related expenses, so the order changes there. Which use fits your situation is ultimately a question of life planning, not just percentages, and belongs in a personal consultation.

The repayment rate change and partial termination after ten years

The unscheduled repayment is built for one-off amounts: a bonus, an inheritance, a maturing policy. If you can repay more permanently, for example after a pay rise, a repayment rate change (Tilgungssatzwechsel) is the better tool. Many contracts allow the repayment rate, and with it the instalment, to be adjusted once or twice during the fixed-interest period. It works like an unscheduled repayment in monthly slices, needs no spare capital and uses none of the allowance. Both together, the rate change plus the repayment right, are the most flexible configuration an annuity loan can have.

The second alternative is in the statute and rarely used: under Section 489 (1) no. 2 BGB you can terminate a loan with a fixed borrowing rate ten years after full disbursement, in whole or in part, with six months' notice and without an early repayment penalty. The "in part" is the underrated half: from that point on you can repay amounts of any size, independent of any contractual allowance. The terminated amount must be paid within two weeks of the termination taking effect, otherwise it is deemed not to have occurred (Section 489 (3) BGB), and the right can neither be excluded nor restricted by contract. It matters most with long fixed-interest periods of fifteen or twenty years, more in our guide to the fixed-interest period.

What to take away from this guide

• An unscheduled repayment right is a matter of contract. Without a clause there is no free repayment right during the fixed-interest period (Section 500 (2) sentence 2 BGB).
• 5 per cent of the loan amount per year, often at no extra charge, is customary. Reference figure, dates and expiry decide what the clause is worth.
• The saving is fixed: the borrowing rate on the repaid amount, until the end of the term. Early beats late.
• The right lowers the early repayment penalty even unused (BGH XI ZR 388/14). It is insurance, not a savers' perk.
• Order before return: first the reserve, then more expensive debt, then the repay-or-invest trade-off. After ten years, Section 489 BGB opens partial termination without any cap.

ME Finance is not a bank and sells no product of its own. We compare offers from more than 500 banks and lenders and pay attention to the clauses that only become valuable years later: unscheduled repayment rights, repayment rate changes, reference figures. How we work is described on our mortgage page. We take your key figures through our no-obligation enquiry.