Calculating Prepayment Penalties in a Transparent Manner

63 Pages Posted: 30 Aug 2007 Last revised: 31 Mar 2008

See all articles by Wolfgang Breuer

Wolfgang Breuer

RWTH Aachen University

Claudia Kreuz

RWTH Aachen University

Date Written: 03/28/2008

Abstract

Special reimbursements for creditors in the case of the premature redemption of mortgaged loans are called prepayment penalties. They have been a controversially discussed topic in Germany for the last decade. This is mainly due to the fact that the European Union judges German prepayment penalties as too high compared to those in other European countries. Since there is no standardized approach to assess prepayment penalties, our paper develops a general computational method with special focus on the calculation of default risk. To this end, a quantification of expected losses as well as costs of equity capital for unexpected losses according to the revised international capital framework (Basel II) is necessary. In order to quantify the costs of equity, the estimation of opportunity costs turns out to be the most promising approach. Summarizing, our paper contributes significantly to a more transparent calculation of prepayment penalties. Therefore, it should be preferred to simply constraining prepayment penalties to a fixed percentage of the loan amount, as it is intended by legislation.

Note: Downloadable document is in German.

Keywords: Basel II, Eigenkapitalkosten, Fungibilitaetspraemie, Standardrisikokosten, Vorfaelligkeitsentschaedigung

JEL Classification: G18, G21, G32

Suggested Citation

Breuer, Wolfgang and Kreuz, Claudia, Calculating Prepayment Penalties in a Transparent Manner (03/28/2008). Available at SSRN: https://ssrn.com/abstract=1010904 or http://dx.doi.org/10.2139/ssrn.1010904

Wolfgang Breuer (Contact Author)

RWTH Aachen University ( email )

Templergraben 55
D-52056 Aachen, 52056
Germany

Claudia Kreuz

RWTH Aachen University ( email )

Templergraben 55
52056 Aachen, 52056
Germany

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