A better a analogy would be your mortgage, which is in fact a debt you owe in full, a payment schedule notwithstanding.
In other words - over the life of the loan/mortgage you will pay $X in principal and $Y in interest. If you suddenly pay the whole thing back, then $Y becomes much smaller. So if you paid $X + $Y in a lump sum then you would receive some money back, is what they are saying. Because you have overpaid on the interest, because that interest never accrued.
(not sure whether in this case Citibank paid the full sum of the principal or expected interest or not, but yes, if you did that on your mortgage then you would be entitled to receive some money back)
High-lvl: prepayment fees is roughly equal to interest owed minus alternative interest options the bank has (eg someone else’s mortgage). Disclaimer: Dutch perspective.
Generally, its been illegal since 2014 nationwide to have a prepay penalty. In my state its been illegal as long as I've had a mortgage. In some weird but possible conditions its possible post-2014 to have a prepayment fee at the national level for a normal residential mortgage.
You'll see all kinds of random dates at the national level. From what I understand the 2010 Dodd-Frank act was the enabling legislation, the new rules came out in 2013, and went into effect in early 2014, but its all the same issue.
And you will take it because where else are you going to get the money?
And you will take it because where else are you going to live?
If you look at things this way, everything is a scam.
Imagine I go to a bank today and take out a $100,000 mortgage on my house at a fixed rate of 2% (yeah - that's 2020) on a 5-year term[0] with a 25-year amortization.
The bank gives me that $100,000 cash today on the expectation that they will get it back with 5 years of interest (calculation is a bit complex but should work out to just over $9k over the 5 years).
We could keep it simple and say that once you've agreed to pay a bank $9k in profit, they are in the business of making sure they get that profit. Repaying any amount of the debt ahead of schedule does not exempt you from paying that anticipated profit.
In the banks' defence, the details are a little more complicated in practice. Banks rarely lend out their own money. When I take out this mortgage, the bank just issues a $100,000 bond to an investor. The bank presumably guarantees the bond so the risk to the investor is less than the mortgage itself and, so, the bond has a lower interest rate - say 0.5%. The difference in interest rates is the actual profit to the bank.
Bonds have a couple characteristics: a) they are fixed-term (in this case, 5 years); and b) payout of both interest and principal is guaranteed (by the bank)
So if you decide to pay back your mortgage (or some amount) ahead of schedule, the bank still has to pay out their bond commitments and that money needs to come from somewhere. And the bank isn't gonna front it. Depending on markets and current interest rates, the bank may be able to re-use that bond on someone else's mortgage so your penalty may be reduced in some cases.
[0] These shorter-than-amortization terms are a thing here in Canada. Not sure if it works the same in other countries.
I think this achieves a similar result, as anyone who leaves their mortgage unchanged beyond the fixed rate period almost always ends up on a punitive rate.
(1)is sacred. If you don’t have (1), you are a noob.
(2)is sometimes bargained away to get a lower interest rate, often, in the form of lower points. Once again, if you have a prepayment penalty without a demonstratable financial consideration, you are a noob.
Don’t be offended, we are all noobs at one time or another. Banks are not educational institutions. Indeed, universities themselves are quite unforthcoming about the opportunity costs and ROI of their own products.
> The interest they get from the debtors is more then the interest they pay depositors.
The interest paid to most accounts these days is a pittance, adding less back than is lost to inflation, and many accounts have additional fees.
Another comparison would be me giving my wallet to a friend to buy something, then the wallet falls from his pocket into my landlord's hands, who declares this must be my next payment for rent. This does not sound fair.
That's not true. For comparison, many times a mortgage lender can call the loan at any time. The service of Brigade loaning the money had already happened.
> Another comparison would be me giving my wallet to a friend to buy something, then the wallet falls from his pocket into my landlord's hands, who declares this must be my next payment for rent. This does not sound fair.
A better comparison would be if your bank mailed a check every month to your mortgage lender, then suddenly sent a check for the exact remaining balance plus interest accrued.