The borrower can always decide to repay a loan early. He or she may consider a partial repayment, or decide to repay the loan in full, for example because he or she has received funds from the sale of the property. The total cost of the loan is updated by the bank: the borrower becomes liable for an early repayment charge (I.R.A.).
1. Definition and reasons for early repayment indemnity
1.1. Compensation for the lender's loss of remuneration
The early repayment indemnity is not the same as the lump-sum indemnity (or indemnity for early repayment).
Admittedly, in both cases it is a penalty that compensates for the breach of contractual relations. However, the I.R.A. is not intended to compensate the lending institution for the time required to obtain repayment of the sums due as a result of the borrower's default.
On the contrary, it is because the latter decides to repay before the agreed term that the indemnity applies.
It therefore has another purpose, which is to compensate the Bank for the loss it suffers as a result of the loss of earnings. In practical terms, partial or full early repayments mean that the bank loses part of its remuneration.
Example: On a 20-year loan, with an average loan rate of 3%, the Bank will necessarily receive less interest than if the loan contract had reached the initially agreed term.
1.2. Other reasons for the legitimacy of the I.R.A.
The I.R.A. also enables lenders to manage the risk associated with the early reinjection of funds into the market.
Early repayments by their customers force banks to find new investment opportunities. However, these may be less favourable due to fluctuating interest rates.
By making early repayment conditional on the payment of a penalty, banks limit the frequency of early repayments.
The I.R.A. is also a source of contractual stability. Its existence dissuades borrowers from repaying their loans unexpectedly.
This allows lenders to forecast their cash flows and plan their financial activities with greater certainty.
2. Legal framework of I.R.A.
2.1. Types of loans concerned
The legal framework varies according to the nature of the loan (consumer loans / business loans):
- Loans governed by consumer law
For home loans taken out by individuals, article L313-47 of the French Consumer Code stipulates that compensation may not exceed the value of six months' interest on the capital repaid at the average rate for the loan, without being able to exceed 3 % of the capital outstanding.
- Business loans
For loans taken out by businesses, IRA conditions are often more flexible and negotiated on a case-by-case basis. Loan agreements generally include specific clauses detailing the calculation and conditions of these indemnities.
The legal framework also depends on the rate of the loan. Variable-rate loans rarely provide for early repayment penalties. However, when they do, they are subject to the conditions set out in the aforementioned article L313-47.
2.2 Exceptions to I.R.A.
When early repayment is the result of a choice by the borrower, who wishes to benefit from a more favourable rate, or who wishes to put an end to his indebtedness, the early repayment indemnity is conceivable.
But is it payable when it is an accident in life that leads to early repayment of the loan, in other words, an involuntary event? Since 1 July 1999, these exceptional cases have been taken into account.
Article L. 312-34 lists the exceptions to this rule and states that no early repayment charge is payable if early repayment is justified by one of the following events:
- the sale of the home following a change in the borrower's place of work or that of the person with whom he or she is living as a couple;
- forced cessation of the borrower's professional activity (redundancy in particular) or that of the person with whom he or she is living as a couple;
- the death of the borrower or of the person with whom he or she is living as a couple
In addition, no early repayment indemnity may be claimed from the borrower in the following cases:
1° In the case of overdraft authorisation ;
2° If the early repayment was made under an insurance contract designed to guarantee repayment of the loan;
3° If the early repayment takes place during a period when the borrowing rate is not fixed.
3. Calculation of the I.R.A. and implementation
To find out the amount or method of calculating the early repayment penalty, you should refer to the clause contained in the loan contract, which is usually entitled "Early repayment". There are various methods of calculation.
3.1 Calculation methods
Some institutions charge a penalty equal to half a year's interest calculated at the agreed rate, excluding insurance, on the amount of capital repaid early.
Others are limited to two months' interest calculated at the agreed rate, excluding insurance, on the amount of capital repaid early.
Others provide no compensation at all, or agree to waive such a sum as part of a negotiation process.
Whichever method is chosen, the clauses must be clearly stipulated in the loan contract, and the calculation must be carried out transparently to avoid disputes.
Failing this, the clause incurs the penalty reserved for unfair terms It will be deemed unwritten by the judge.
3.2 Implementation
For early repayment, it is preferable to use a paper form.
The borrower should send a registered letter with acknowledgement of receipt to the bank. This will notify the borrower of their decision to make an early repayment, specifying whether the loan is to be repaid in full or in part.
On receipt, the bank must provide the borrower with a costed estimate of the cost of the decision to repay early.
For all loan contracts concluded since 1er July 2016, this estimate does not have to be invoiced by the Bank.
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