The Price Of Repaying Your Personal Loan Early

Every loan approval from any bank or lending firm in Australia comes with an agreement about some specific and general terms and conditions. As you take out a personal loan with a fixed interest rate, you are essentially agreeing to a contract binding you to lock in your interest rate for an agreed period of time. If your fixed interest rate is 2.5%, this will be the applicable rate for your loan repayment even if the prevailing interest rate is lower or higher than 2.5%. It means your interest rate at the beginning of your loan repayment period is 2.5% and it will still be 2.5% at the end of your loan term.

Regardless of the downward or upward movement of the market’s interest rate, your fixed interest rate remains the same throughout the loan repayment term. So what happens if you decide to repay your loan early? Say, you were able to obtain the needed amount to settle the loan balance earlier than the agreed schedule, will there be any financial implication on the balance or the interest rate?

In essence, you are breaking the agreed fixed rate term if you opt to repay your loan early. Breaking a contract or agreement will cause the other party financial losses and it is common practice that the party who breaks the agreement will compensate the other party for such loss. In the same light, banks and lending firms in Australia apply this common practice and charge the loan recipient Early Repayment Adjustment (ERA) to cover their losses.

While it’s true that your early repayment will essentially get the bank or lending firm out of risk from financing your loan, it is also true that when they process your loan, they have locked in their funding costs at a fixed rate. A change in the contract or agreement terms would necessitate the banks or lending firms to unwind their fixed rate funding. When this happens, the banks will calculate if they incurred losses using the interbank lending rates known as “wholesale market swap rates”. The wholesale market swap rates equalize the cost difference between fixed rates loans and variable rates loans, from time to time and from term to term.

Australian banks explain that ERA is neither a penalty nor a fee and that they don’t make profit from it. ERA is simply an adjustment necessary to recoup their loss as a result of the loan recipient from breaking the agreed terms.

Your loan balance may be settled earlier than the agreed terms in any of the following ways:

You may increase the frequency of your repayments. Instead of fortnightly, you can make your repayments on a weekly basis.

Make larger repayments. You may choose to add a certain amount to your scheduled repayment amount. You may double the amount every repayment period.

Make lump sum repayments. You may make lump sum payments to reduce your total repayment amount.

If your loan term is not based on a fixed interest rate, by paying your loan early, you are making a savings on interest payments.

Comments are closed.