Is there a loan such as this?

[Tyler Durden]

Is there a type of loan where even if you pay out the balance earlier, it still equals to the amount you would have paid had you not paid out the loan earlier?

To make sense of it, I will try to provide a hypothetical example. Let's say you borrow $10,000 at 15% pa, and you want to repay it over 3 years, so monthly repayments are $346.65 (got this figure from an online loan calculator). If you were to pay in accordance with the agreement, at the end of the 3 years you would have paid $12,479.40 ($346.65 x 36 months).

But let's say after 20 months, you have made total repayments of $6,933 ($346.65 x 20 months), which means the balance of your loan is $3,067 (10,000-6,933) and you want to pay out the balance. Shouldn't the pay out figure be $3,067?

Or is there a type of loan where the pay out figure is the balance of the agreed amount, which includes interest, which in this case would be $5,546.40 ($12,479.40 - $6,933)?

 

[Whiskers]

There are many types of loans with any number of terms and conditions, including penalties for such things as early repayments.

You will need to fully understand the terms of the particular loan you are entering into to be able to calculate the final cost and early payout figures.

Penalties for early repayment of loans has caught a lot of people out in recent years.

 

[Tyler Durden]

There are many types of loans with any number of terms and conditions, including penalties for such things as early repayments.

You will need to fully understand the terms of the particular loan you are entering into to be able to calculate the final cost and early payout figures.

Penalties for early repayment of loans has caught a lot of people out in recent years.

Are these penalties often worth the same or more than the amount that would've been paid had it not been repaid in advance?

 

[bellenuit]

Is there a type of loan where even if you pay out the balance earlier, it still equals to the amount you would have paid had you not paid out the loan earlier?

To make sense of it, I will try to provide a hypothetical example. Let's say you borrow $10,000 at 15% pa, and you want to repay it over 3 years, so monthly repayments are $346.65 (got this figure from an online loan calculator). If you were to pay in accordance with the agreement, at the end of the 3 years you would have paid $12,479.40 ($346.65 x 36 months).

But let's say after 20 months, you have made total repayments of $6,933 ($346.65 x 20 months), which means the balance of your loan is $3,067 (10,000-6,933) and you want to pay out the balance. Shouldn't the pay out figure be $3,067?

Or is there a type of loan where the pay out figure is the balance of the agreed amount, which includes interest, which in this case would be $5,546.40 ($12,479.40 - $6,933)?

Yes, some loans are of that type. They calculate the total interest applicable over the term of the loan, add it to the principal borrowed and divide by the number of months in the term to arrive at monthly payments. If you decide to terminate early, you will either have to pay the balance owing (monthly repayments X months remaining) or, most likely, have to pay a penalty fee to terminate early.

Fixed interest home loans are of that type. The interest is fixed for a specified period (usually 5 years max) and, although most will allow you to terminate early, they have a complex formula to determine the penalty that will apply for early termination.

You need to read the fine print to see what early termination entails.

I think the rational behind such loans is that the lender borrows the money that they lend you on terms that match the term of your loan (they borrow over 5 years the money that they will lend you over 5 years). If interest rates drop substantially and you want out (because you know that you can get another loan at a much lower rate), the lender may still be committed to paying off the money they borrowed at the rate applicable until the end of the term.

I don't know if this is a real example, but if a lending institution issues 5 year bonds to the public to provide funds for 5 year fixed interest loans (the rate they pay on the bond face value will be lower than the rate they charge you obviously), then they are still committed to paying that interest rate to the bond holders for the full term of the bond, so they may lose money if you could opt out part way through if interest rates fall in the interim.

 

[bellenuit]

Are these penalties often worth the same or more than the amount that would've been paid had it not been repaid in advance?

In general I would think not. But if you are close to the end of the loan term, then the penalty might exceed what would have been the remaining payments because of the additional administration overhead that early termination might cost them.

 

[Judd]

Is there a type of loan where even if you pay out the balance earlier, it still equals to the amount you would have paid had you not paid out the loan earlier?

To make sense of it, I will try to provide a hypothetical example. Let's say you borrow $10,000 at 15% pa, and you want to repay it over 3 years, so monthly repayments are $346.65 (got this figure from an online loan calculator). If you were to pay in accordance with the agreement, at the end of the 3 years you would have paid $12,479.40 ($346.65 x 36 months).

But let's say after 20 months, you have made total repayments of $6,933 ($346.65 x 20 months), which means the balance of your loan is $3,067 (10,000-6,933) and you want to pay out the balance. Shouldn't the pay out figure be $3,067?

Or is there a type of loan where the pay out figure is the balance of the agreed amount, which includes interest, which in this case would be $5,546.40 ($12,479.40 - $6,933)?

You are referring to what is known as Balloon payments.

You may have overlooked that the amount of repayment includes both principal and interest. On your first scenario, the outstanding balance is around the 5,000 - 5,400 mark depending on which online calculator you use. Have a look at how the Rule of 78 applies (for 36 months it is the Rule of 666 believe it or not - its the sum of the digits (months) in the loan agreement.)

And as Whiskers posts there may be an early payout penalty as well.

I prefer to use a trusty old calculator to do the numbers but now I am shifting to that more modern thngy called a spreadsheet and using the various financial formula they contain.

 

[Tyler Durden]

Wow thanks guys, very informative responses, much appreciated. I thought the loan sounded like a bad, dodgy deal, but didn't look at it from the perspective that the lender would be borrowing and hence have their own costs.

 

[Whiskers]

Are these penalties often worth the same or more than the amount that would've been paid had it not been repaid in advance?

What are you thinking of borrowing money for?

There are a number of different ways to get short term, variable amount and repayment option loans, such as an overdraft or bridging loan.

If the application of the loan is tax deductible it's wiser to borrow directly for the loan.

But otherwise there are credit cards out there that charge fairly low rates similar to personal loan rates on purchases ( they are mostly sky high for cash advances). A common strategy for non deductable stuff I know is to leave your cash invested and charge up as many as possible purchases on the credit card at low interest and leave other cash income to buy those things that you would otherwise need to sell some assets like shares or take out a short term loan for eg a new kitchen or new car.

 

[Julia]

Wow thanks guys, very informative responses, much appreciated. I thought the loan sounded like a bad, dodgy deal, but didn't look at it from the perspective that the lender would be borrowing and hence have their own costs.

For the same reason, banks apply a significant penalty for early withdrawal of a term deposit. i.e. they have calculated having the use of those funds for the term agreed.