Paying off a loan early might seem like an obviously good thing to do. After all, with interest the longer you pay for a loan, the more it costs right? Well unfortunately for that very reason lenders will put extra roadblocks in your way when trying to pay off a loan early and in this article we’re going to go over some of the most common ones.
Precomputed Interest
A common practice in car loans is “precomputed interest” ; this is when all of the interest that you will pay throughout the loan term is already calculated and added together. For an overly simple example if you paid $100 for 5 months with $5 of interest per month then the precomputed interest would be $25.
If a loan is using precomputed interest then it’s possible that paying early will not actually save you any money at all, as the remainder of the interest that hasn’t been paid yet will just be added on to your early payment as an extra fee.
Even without precomputed interest, lenders often still charge “prepayment fees” on top of any attempts to pay off a loan before the term finishes.
Early Payment
If you’re not intending to pay off a loan outright, but are instead looking to just put some extra money towards it and hopefully end the loan sooner than you may fall into a little trap without realising. Some loans have a repayment mechanism known as “early payment” which means that instead of being put towards the loan as it stands, the money you put towards the loan will instead be stuck in limbo and put towards the next official payment date instead.
The lender will simply not charge you for that payment, as you’ve already paid it early in their mind. This isn’t necessarily bad but it’s certainly not your intended outcome here.
No Principal Payments
There’s two parts of a loan: the principal amount, which is the amount you actually borrowed, and then the interest. A typical loan repayment pays for a bit of both. However it financially makes more sense to pay off the principle first because that’s the part that the interest is calculated on, the smaller you can make it the less interest you’ll pay. Which is exactly why most lenders will not allow principal only payments.
Just Saying No
Saving the most simple for last but some lenders will just refuse to let you repay a loan early. If you do end up in that situation or with any of the other problems then the best option might be to try and refinance the loan.