When you apply for a loan from a bank, along with the agreement you receive a payment schedule with the exact dates when you need to make payments. Many clients believe that money must be transferred exactly on the specified date. But, as a rule, you can repay the loan ahead of schedule. This is known as Loan Settlement. This allows you to reduce overpayments that account for interest. In this article, we will tell you how to pay off debts correctly, and also describe the methods and procedures for repaying loans without negative consequences for your budget.
Loan Settlement Process: All You Need To Know
Is it worth paying off your debt early to settle your loan?
Should I repay the loan early? Many borrowers do not even consider this option, relying on auto payments or EMIs. Thanks to this service, a certain amount is withdrawn from the account every month, and the person spends the leftover money on personal needs.
But do not forget that the longer you use borrowed funds, the more you overpay. This is how bank interest works, which is usually calculated on the remaining amount during the period of use of the money. Thus, if you repay the loan ahead of schedule, the total overpayment can be significantly reduced. Loan settlement certainly sounds like a good idea in this case.
Can banks refuse loan settlement?
No, by law, banks are required to allow early repayment of a loan if the client has expressed such a desire. If you have available funds, this opportunity is worth taking advantage of.
When is loan settlement profitable?
If you want to reduce costs for additional services. Some loan programs involve the purchase of compulsory insurance – for example, for a loan car. After the expiration of the contract, insurance will have to be taken out again. But these costs can be avoided by closing the loan earlier.
If you want the property purchased with borrowed funds to be at your complete disposal as soon as possible. Thus, early repayment of an apartment loan will allow you to complete purchase and sale transactions faster.
Early loan settlement: how to apply
Closing a loan early is the simplest process possible. Sometimes this can be as simple as logging into the online application and paying more than your monthly payment. In this case, the payment schedule will be updated automatically.
Some banks allow borrowers to close their loans early through an online application. Others do it the old-fashioned way and encourage customers to apply to a bank branch.
You can close either part of the loan or the entire debt ahead of schedule. In the first case, there are usually no restrictions on the amount of contribution. You can transfer any amount comfortable for you from above, subject to the availability of available funds.
When depositing money, it is worth considering that the bank will take part of the amount to pay off interest and only the rest to pay off the principal of the loan. Thus, if you deposit an additional amount of 50 thousand rupees, this does not mean that the loan will decrease by this amount. Moreover, the borrower does not have the opportunity to choose whether to repay the principal or interest.
How to repay a loan early?
In case of early repayment, the money first goes towards the accrued interest.
What to reduce: loan term or monthly payment amount
You can choose what the additional funds contributed will be used for, to shorten the loan term or to reduce the monthly amount. In the second case, the loan period will remain the same.
How to make the most of your loan repayments depends on your situation and priorities. These options can be combined. One of the best ways is to reduce the payment to an amount that is comfortable to pay monthly, and then reduce the payment term.
What is the best time for loan settlement?
How to pay off debts correctly? The answer is simple: as soon as possible, because the bank charges interest for each day you use the loan. That is why it is more profitable to make small payments regularly than to first save and then transfer a large amount to early repayment of the loan.
Important! It is worth considering that some banks provide their clients with the option of early repayment only on the day of loan repayment.
How to pay off multiple loans?
What to do if you have two or more loans? Here are two main methods:
Avalanche Method
From a mathematical point of view, it is best to pay off the loan with the highest interest rate first. For example, if you have a loan to buy a car at 15% and a loan to buy a house at 10%, then it is more rational to pay off the first one first. This way you will save yourself from unnecessary overpayments. This procedure for repaying debts is called the “avalanche method.”
Snowball Method
There is another procedure for repaying a loan – the “snowball method”. It involves paying off the smallest debts first and then moving on to larger loans. This method is suitable if the interest rate on different loans does not differ much. Thus, the principal debt will be repaid last. This method brings psychological relief to the borrower: he has fewer debts, and the freed money can be used to close other loans ahead of schedule.
Should you settle expiring loans quickly?
As a rule, it is better to pay off a recently opened loan in advance, rather than one that expires in a few months. The fact is that for a loan that closes in 3-5 months, the overpayment is minimal – almost all the interest has usually already been paid by that time. In this case, it makes sense to focus on paying off the longer loan, even if it has a lower interest rate.
To understand which method will be optimal in your particular case, it is worth calculating both debt repayment options using financial calculators that can be found publicly available on the Internet.
Are there any disadvantages of loan settlement?
It is not profitable for a financial institution when a client repays a loan early. The bank does not have the right to prevent this, but it may refuse to issue a loan in the future. So, if you frequently take out loans and pay them off in a short period of time, this may affect your credit history and potentially reduce the likelihood of new applications being approved.
If you use borrowed money regularly, it is more rational to get a credit card. In this case, early debt closure has a positive effect on your credit history.
Keep in mind that early repayment of a loan may not be so profitable during a period of rapidly growing inflation, when money becomes cheaper. In this case, it is worth considering whether to repay the loan ahead of schedule or take advantage of the fact that the amount of the debt is fixed.
Mistakes made during loan settlement
These are the mistakes that borrowers can make while opting for early loan settlement:
- Save money until you reach a “round sum”, and then pay it in one large payment. This is not profitable, since interest is charged for each day the loan is used. The earlier you make your payment, the less you will have to overpay.
- Wait until your monthly payment date to pay the additional amount. This should not be done for the same reason: during this time more interest will be accrued.
- Do not study the agreement concluded with the bank. The policies of different financial institutions have their own nuances regarding early loan repayment. Some banks require you to warn them about this and may impose financial sanctions for violations. Other financial institutions have restrictions on the minimum additional amount that can be deposited ahead of schedule.
- Give all the money for early repayment, without having a “safety cushion”, especially during periods of income instability. If you want to close your loan early, be sure to keep a financial reserve that you can use for unexpected expenses.
Loan settlement: Conclusion
In early repayment of loans, discipline and a precise understanding of the procedure for repaying debts are important. The sooner you pay off your debt, the less overpayments there will be. Try to regularly pay more than the monthly payment, and the term of your loan, and therefore the costs, will decrease. Loan settlement is a good financial tool, but you need to know how to use it.
