Early repayment of the loan: Borrower's right to reduction in the total cost of the credit and bank's compensation right
By George Kazoleas, Lawyer LL.M.
The right of early repayment of the loan by the borrower is enshrined in both European law and national legal systems. There are essentially two main effects of this right’s exercise: On the one hand, the consumer/ borrower is entitled to a reduction in the total cost of the credit consisting of interest and charges for the remaining period of the contract. On the other hand, the bank shall be entitled to reasonable and objectively justified compensation for any costs directly linked to early repayment of the credit, provided that the early repayment is made within the period for which the borrowing rate is fixed. (Article 16 (1) of Directive 2008/48).
The relative clauses used by most banks regarding the issue of early repayment of the loan are vaguely worded and non-transparent and have therefore been repeatedly declared illegal, unfair and abusive. It is commonly stated that compensation includes any costs, expenses, losses, or liabilities that the bank may incur as a result of early repayment. It does not specify, however, what the costs, expenses, etc. are, but it is left to the credit institution's absolute discretion to determine the amount of compensation unilaterally and without actual control by the consumer. Such a clause which, put in place by the strong party and despite the requirement of good faith, creates a significant disproportionate burden on the consumer between the rights and obligations of the parties to the contract is found to be abusive and unfair.
According to Article 16 of Directive 2008/48, compensation for early repayment shall not be claimed: (a) if the repayment has been made under an insurance contract intended to provide a credit repayment guarantee;
(b) in the case of overdraft facilities; or
(c) if the repayment falls within a period for which the borrowing rate is not fixed.
In conclusion, the compensation claimed by the bank in case of early repayment of the loan must be definite and limited and its calculation must be understandable and transparent for the consumer. It should relate to any costs that are directly linked to early repayment, also taking into account the amounts which the bank may have saved from inflating the repayable amount. The calculation of the creditor's compensation should be transparent and comprehensible to the consumer from the pre-conclusion stage, in any case during the execution of the credit agreement. In addition, the method of calculation should be easy to apply by creditors and promote supervisory control of compensation by responsible authorities.
The right of the borrower to reduce the total cost of the credit
The exercise of the right of early repayment of the loan by the borrower implies its right to reduce the total cost of the credit. What does this cost include, Directive 2008/48 specifies:
“The total cost of the credit to the consumer should comprise all the costs, including interest, commissions, taxes, fees for credit intermediaries and any other fees which the consumer has to pay in connection with the credit agreement, except for notarial costs. Creditors’ actual knowledge of the costs should be assessed objectively, taking into account the requirements of professional diligence”.
In determining the total cost of the loan, charges and expenses that depend on the duration of the loan agreement and those that are not dependent should be distinguished. If the latter are not included in the total cost of the loan, the consumer / borrower's right in this regard is limited and weakened. Banks will only provide for costs and charges that are not subject to the term of the loan agreement, in order to prevent such costs from being included in those related to the reduction of the total cost of the credit, which the borrower will be entitled to when prematurely repays its obligations.
The recent decision of the ECJ of 11 September 2019 in Case C ‑ 383/18 provides that the right of the consumer to reduce the total cost of credit in the event of early repayment shall include all costs incurred, the payment of which was charged to the consumer and therefore costs and charges that are independent of the duration of the loan agreement.
The Court bases its judgment in stating that “the effectiveness of the right of the consumer to a reduction in the total cost of the credit would be reduced if the reduction of the credit could be limited to the taking into account of only those costs presented by the creditor as dependent on the duration of the contract, given that …the costs and the breakdown thereof are determined unilaterally by the bank and the charging of fees may include a certain profit margin…
In addition… limiting the possibility of reducing the total cost of the credit solely to costs expressly connected with the duration of the contract would entail the risk that the consumer would be required to make a higher one-off payment when concluding the credit agreement since the creditor could be tempted to reduce the costs depending on the duration of the contract to a minimum…
Furthermore… the degree of flexibility available to credit institutions in terms of invoicing and internal organisation makes it very difficult in practice for a consumer or a court to determine which costs are objectively linked to the duration of the contract”.
In view of the above we can come to some conclusions:
1. The borrower's early repayment right implies his right to reduce the total cost of the credit, which includes all costs incurred by the bank.
2. The compensation which the bank is entitled to exercise of the above right shall be definite and limited and the calculation of it must be understandable and transparent for the consumer. It should only concern any costs that are directly related to early repayment. Clauses referring to compensation that generally and indefinitely include any costs, expenses, damages, losses or liabilities that the bank may incur as a result of early repayment are unlawful, abusive and have no legal effect.
3. It must not be forgotten that the bank, through early repayment, recovers the loan amount early, which apparently uses when concludes a new credit agreement and thus imposes new charges and commissions. In addition, early repayment of a loan ensures that it will never become unsecured. It is therefore not particularly critical to argue that the bank is suffering significant damage from early repayment, even to the extent that it entitles it to claim unfair compensation.*George Kazoleas is Senior Associate Lawyer at Dionysiou & Partners LLC, Cyprus