Is it right to pay off a loan early?

September 28, 2020September 28, 2020 MoneySense

Whenever you take out a loan, you are bound by an agreement that contains all the details of the borrowing including interest rates, loan amount, and loan tenor. The agreement should also indicate the terms and conditions of the loan. Your signature implies that you agree to whatever was indicated in the contract including payment of fees and penalties should you intend to break away from it.

Over time, you might find yourself in that wonderful position of having the money to pay off the full loan early. Whether it is a personal loan, mortgage, car loan, or home loan, paying off a debt earlier than the date indicated in the agreement comes with a price.

What is a loan tenor?

Tenor refers to the duration until the financial contract expires. The lender expects that you should have returned the money borrowed at the end of the tenor through repayment of monthly installments. It is also known as maturity as it refers to the end of by which the agreement matures.

When should you opt for early loan repayment?

Early loan repayment is advisable to people who have the money to settle the debt. Knowing that you can get out of a huge obligation earlier than expected is a huge relief. However, the issue lies in the practicality of early repayment. Debts come with interest rates and closing them off ahead of the agreement comes with fees and penalties. Some lenders would ask for a penalty which is around 4% of the remaining balance. Aside from that, a processing fee of at least Php1,500 is also added on top of the unpaid amount.

For you to know whether you should pay off your loan ahead of its maturity, here are a few things you should consider:

1. Prepayment fees

Prepayment fees serve as the penalty for calling off the loan too early. They also serve as an assurance that the lender will still be earning from the loan even if it will be lower than the entire earnings should the loan mature. Understandably, lenders will lose money as you break away from the agreement. They are supposed to earn the entire interest cost charged for the term. Penalties for prepaying a loan are prohibited by the Consumer Act of the Philippines. Lenders found a way to charge the same as they call them processing fees entailed with the loan termination.

2. Monthly expenses

Before you hand your full payment for the loan, think about your monthly expenses. Is the money an extra income or you’re going to use what’s meant to be spent on your monthly bills and other obligations?

Paying off a loan with your monthly budget will not make sense because your monthly bills are priority obligations. It is crucial that you set aside enough money for all recurring expenses and debts. It is best to opt for early repayment with an additional income without sacrificing money meant for your necessities.

3. Interest rates

Most consumer loans like a personal loan and car loan have fixed interest rates. Comparison platforms allow you to check and compare personal loan offers and interest rates. However, you might be taking out a new loan to prepay an existing loan early. Compare how much interest rates are charged on the new loan against the once imposed on your existing loan. In general, other types of loans have much higher interest compared to a personal loan. Some credit cards offer cash advance out of your credit limit. It is an easy way to get funds but it generally costs around 3.5% per month, excluding a one-time charge of at least Php500.