Aidil recently got a promotion and is wondering what to do with the extra cash. But with the current cuts in interest rates, he doesn’t want to put his money into a fixed deposit as the interest he will get is quite low. He’s also not ready to start investing, so he’s thinking of other ways to use his extra cash. Aidil could increase his monthly repayments to pay off his loans earlier, but does he save money by doing that?
Different types of loans are affected differently by early repayments. Let’s see how this works.
Can you save money by repaying your loans early?
In short, yes. But the total amount you can save with different types of loans can be different.
By paying more towards your hire purchase loans, you will pay off your loans earlier and you can get a rebate on your interest from the banks.
By paying more, you will pay off your loan earlier and you will be saving money by paying significantly less interest.
Why is it different for both loans?
Hire purchase loans are calculated on a flat interest rate. Flat interest rate loans have an agreed interest amount when you take the loan which is spread out evenly in your monthly payments. So when you make higher monthly payments, it goes towards paying off both your principal and interest. By finishing the loan early, the bank will give you a rebate.
Housing loans are calculated using a reducing balance method. For reducing balance loans, the interest is charged on the remainder of your principal amount. So as you keep making payments, the principal goes down and the interest charged on the loan gets less and less. You can end up saving a lot of money by doing this!
However, for some loans, you may be charged a penalty for paying off your entire loan early as it may have a minimum period to keep your loan before you are allowed to make a full settlement.
So, make sure you speak to your banks to understand the terms of your loan agreement before deciding whether to pay off your loans earlier than what you agreed.
Paying off your loans means you’re reducing your debt. So if you can afford it, paying off your loan early is a good idea, as long as you won’t be charged extra fees or penalties. But if you can’t afford it, the best option would just be to make sure you make your monthly repayments on time!