Sondertilgung: A popular but overrated option

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Who doesn't like the idea of repaying extra on their mortgage to avoid penalties? That is what “Sondertilgung” is, and virtually every mortgage borrower wants it. It is a great sales argument for advisors: If you were to use your extra payments/savings/bonuses, you could be done with your mortgage by year "X".

Why is Sondertilgung by and large a dead option?

  • First, when interest rates are low, you should not repay your mortgage but invest in higher-yielding assets like stocks (through cheap well-diversified ETFs) or save for a second home to rent out. If you earn 1 percent on repaying your mortgage but can earn 5 to 7% elsewhere, it typically is not a good idea to repay. Of course, you need a long enough time horizon. So for most people under 50 to 60, I would strongly encourage alternative investments that help them save for their life expectancy of 90+ years. 

  • Second, when interest rates at some point during your mortgage go up considerably, say to 4 percent, it becomes a good idea to repay extra on your mortgage. But not using Sondertilgung. At that point, you should put the money in a bank account – at a fixed-term deposit that runs to the end of your fixed interest rate period. The reason is that the bank will pay a higher rate (2 to 3%) than the interest rate you save on your mortgage (about 1%). When your fixed interest period runs out, you take the money from the bank and use that to reduce your loan size. 

Of course, if you have an existing mortgage with a high-interest rate, it is a great benefit. But with interest rates that are still at a very moderate level, this presumably won’t apply for future mortgages.

Discover your personal mortgage options with our German mortgage calculator.

Is Sondertilgung at the present juncture hence an entirely bad idea? 

No. It does have an interesting potential benefit. If you had to sell your house before your fixed interest rate period is over (and less than 10 years after getting the mortgage), it does reduce the early departure penalties.

As you may know, the bank charges you a penalty if they earn less on reinvesting the mortgage money that you repay early. However, the banks must deduct the potential unscheduled repayment from the penalty base, since they must assume that you will use the option.

Say you have five years left on a mortgage, then a Sondertilgung of 5% per year could reduce your average balance for years 6 to 10 by about 15%.* This would hence reduce your penalty by about 15%. Not much, but still some benefit.

* The precise percentage is not straightforward to calculate. It depends on the extent you have already repaid your mortgage and is higher than the simple average as it assumes you would pay the Sondertilgung as soon as you can each year.

In conclusion: The main benefit of getting Sondertilgung on your mortgage in the current low-interest environment is that it can save you a bit on the penalty if you sell your house early.  

If that doesn't apply to you, you are better off investing your money in higher-yielding assets like stocks. Discover the smartest ways to invest in ETFs in Germany.

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Dr. Christian Mulder

Dr. Christian is a former Senior Economist and Manager at the IMF and World Bank. He is a Hypofriend Co-founder.

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