Repaying your mortgage early: when is it worth it?

Paying off your mortgage before it's due has its pros and cons. But whether the advantages out weigh the disadvantages depends on when you do it: there is a moment when it is better to do so and also when it isn't. We're going to look at when the correct moment is, how to ask to pay off the loan early, and what factors to take into consideration when trying to determine if this is a good solution for you.

What is early repayment of a loan?

Paying off a loan early means repaying the loan contracted for the purchase of the house before the natural expiry of the repayment period. This is an option that avoids us having to pay the installments between the repayment and the deadline, and usually becomes possible when we come into possession of a sum of money that can be used to wipe out the debt in one go. Early repayment, whether partial or total, is provided for by the Banking Consolidation Act, article 40 paragraph 1, which establishes that "debtors have the right to pay off their debt in advance, in whole or in part, by paying the bank exclusively an all-inclusive fee for the contractually established termination".

How to pay off a mortgage

• Total repayment of the loan

The loan can be fully or partially repaid. In the event of total repayment of the loan, the entire residual amount of the debt with the bank is repaid in a lump sum. In this case, if the loan was contracted before April 2, 2007, the administrative costs as well as interest calculated for the period between the last installment paid and the payment of the entire sum must also be added to the sum, in addition to any penalties applied.

• Partial repayment of the loan

The partial repayment of the loan, on the other hand, consists in paying the bank only a part of the residual debt, with the aim of reducing future installments or shortening the total duration of the repayment period. In the event of a penalty (for mortgages prior to April 2007), the penalty is calculated only on the partial amount returned.

Calculation of early repayment of the loan

When the loan is terminated early, it is the bank that must be asked to calculate the sum to be repaid up to the chosen date. Any costs will be added to the amount of the residual capital, already available in the repayment plan, with the addition of accrued daily interest.

How to request the early repayment of the loan

To ask your bank for the early repayment of the loan, you must send your bank a registered letter with acknowledgment of receipt in which to communicate the request and ask for the exact calculations of the amount to be paid. The application form is available at the bank and must be returned with a copy of an identity document and tax code attached. In the event of a loan contracted before April 2007, a substitutive declaration of deed of notoriety must also be attached, in order to apply the reduced penalties provided for by the Bersani Law. The bank will issue the appropriate documentation within thirty days, after carrying out all the necessary checks.

Mortgage: when is it worth paying it off?

To understand whether or not it makes sense for to pay off the loan, partially or totally, you first need to be clear about what your reason is to repay it early, and what is your financial ability to do so. To pay off the loan, you first need to have the necessary amount available to do so. But there are also other factors to consider:

• Which goal: paying off the loan means avoiding accruing new interest to add to the repayment of the original sum, or at least reducing the weight of future installments.
• Number of remaining installments: the progress of the loan is an important factor to understand regarding whether early repayment is sensible or not. If the loan is already close to maturity, it is not particularly benificial to pay it off early, while it could be more benificial, even if it requires greater means, to pay it off at the beginning of the repayment plan.
• French-style interest: regarding the previous point, if the loan is using a so-called "French-style" repayment plan, at the beginning of the repayment period you will have to repay a greater amount of interest than the principal amount; towards the end of the period, on the other hand, there will be a greater portion of residual capital and less interest. Therefore, if you want to reduce the amount of interest to be repaid, the best time to pay off the loan is at the beginning of the repayment period.
• Implied return: There is also the question of the "trade off" between investing the capital to repay the mortgage or to look for another type of income, for example by purchasing securities or the like. Only if investing this sum yields less than the interest saved by repaying the loan in advance, then it is better to use it to repay the loan.
• Psychological factor: In addition to the purely economic question, there is the possibilitythat you cannot psychologically bear having to carry a debt that lasts many years and therefore, you want to pay it off as soon as you can. If this is the case, as soon as you have an extra sum, it is likely that you will invest to repay the mortgage, thus freeing yourself from the obligation of installments and finally enjoying full ownership of your home.
• Euribor rate: if you have a variable rate mortgage, to understand if it is a good time to pay off the loan, it is also essential to keep an eye on the Euribor rate, in particular the three-month one, which is the basis for calculating the mortgage interest floating rate in Italy. At the moment the rate is at an all-time low even if some signs have recently been indicating it will rise, though this is unlikely to take place before the second half of 2022. It may therefore be worthwhile to pay off the loan before the rate starts to rise again so as to avoid higher interest.

Early repayment of the loan: costs and penalties

With the Bersani law (decree no. 7/2007, converted into law no. 40/2007), the early repayment of the loan does not bear any penalty. However, some distinctions need to be made. If a loan was contracted after February 2, 2007 - the moment of entry into force of the Bersani Law - no penalty is applicable for its early repayment. However, given that extinguishing a mortgage before its expiry erodes the interest collected by the banks, which still want to obtain some compensation, sometimes early repayment is permitted by contract only after a certain number of months have elapsed (for example, 18).

For mortgages contracted before April 2007, the Bersani Law introduced reduced penalties in the event of early repayment, also sets limits that the borrower is entitled to request are respected, without the bank being able to oppose them.

The maximum applicable limits of the penalties for mortgages prior to April 2007 repaid early are:

• For variable rate mortgages:

1. In case of extinction before the third to last year from maturity: 0.5%
2. In case of extinction in the third last year: 0.2%
3. In case of extinction in the last two years: 0%.
4. If the penalty of the loan agreement is equal to or greater than the maximum allowed, there is a reduction of 0.2%

• For fixed rate mortgages

In the case of mortgages signed from January 1, 2001:

1. Settlement in the first half of the repayment period: 1.9%
2. Settlement in the second half of the repayment period: 1.5%
3. In the third last year: 0.2%
4. In the last two years: 0%

Also in this case, reductions apply:

• equal to 0.25% if the contract penalty is equal to or greater than 1.25%
• equal to 0.15% if the contract penalty is less than 1.25%.