How are early payments of loans calculated?

Atirez

Hi all, I am wondering how the banks calculate early repayments of loans. The reason for this is: interest is charged on the capital monthly across the term, to calculate the total interest paid. Does that mean that on say month 12, I have paid mostly interest and the principal I would repay would hardly have changed from the original. That reads a bit badly so; using an amortization table in excel.

E.g. (payment 12 of 60 on a £10k loan at 6.1% APR)

Payment of 193.79
Principal 151.16
Interest 42.36
Current balance: 8235.69
Total interest paid: 561.21

So if I wanted to pay this example loan of after that payment I would need to pay £8235.69?

Tixy

Yep - pretty much.

Most loans have early settlement interest added if you settle early which is typically equivalent to 2 months interest (so another £83 or so).
So the capital balance would likely be the £8235 but the amount required to settle could be £8318 or so. But check the T&Cs of the loan to clarify.

CLAPTON

Atirez wrote: »

Hi all, I am wondering how the banks calculate early repayments of loans. The reason for this is: interest is charged on the capital monthly across the term, to calculate the total interest paid. Does that mean that on say month 12, I have paid mostly interest and the principal I would repay would hardly have changed from the original. That reads a bit badly so; using an amortization table in excel.

E.g. (payment 12 of 60 on a £10k loan at 6.1% APR)

Payment of 193.79
Principal 151.16
Interest 42.36
Current balance: 8235.69
Total interest paid: 561.21

So if I wanted to pay this example loan of after that payment I would need to pay £8235.69?

nearly so

you need to look at the T&Cs but you would have a little more interest to pay anyway (interest accrues daily so some would have accrued since the statement date) and also they might apply up to two months penalty.

so you need to ask them for a settlement figure

Atirez

Ugh, so it feels like if you have had a loan for a number of years it is really rather pointless to try and pay it off earlier, because in terms of interest paid the damage has already been done.

Atirez

It seems I have been somewhat naive in my understanding of how these things work. And working out the most cost effective way of becoming debt free is a little more complicated than I originally imagined.

I originally worked it out by looking at monthly payments covering debts and was going to pay them off in relation to the monthly amount I was paying to snowball that money in to paying other debts off. Now, I think it may be better perhaps to make overpayments to debts that are new (in terms of loans) then to repay almost repaid loans. Yes, all in all, a lot more complicated...

JSR

No it's simpler than that. Always overpay the debt with the highest rate of interest.

It's true that most of the repayment in the early years of a loan is interest but you still only pay interest on the actual amount owed. They do it like that so you can have a fixed monthly payment, otherwise your repayment would start off much higher at first and get lower over the years.

Paying £100 off a 6% debt will save you £6 over a year but paying the same £100 off a 10% debt will save you £10 over a year. It doesn't matter when the debt was taken on. It's always better to pay off higher priced debt first.

CLAPTON

Atirez wrote: »

Ugh, so it feels like if you have had a loan for a number of years it is really rather pointless to try and pay it off earlier, because in terms of interest paid the damage has already been done.

no this is exactly the wrong conclusion


as you haven't paid most of the interest yet then paying off the debt will avoid most of the interest that would otherwise have become due.

billymadbiker

I also struggled with this one.
I had a £10k loan over 4yrs a while back.
After paying for 3 years the settlement amount only worked out at £60 less than the remaining monthly payments.
Due to the fact that I was paying more intrest at the start (as I owed them more money) it worket out that it was only costing me £60 odd to continue borrowing the remaining £3k for another year.
Obviously I could have looked at it closer and put the debt onto a 0% card or something but, as I had the cash to pay it off, I spent it on stock for work where the large purchase gained me a 20% discount on stock so saved me over £500 anyway.

BillJones

Atirez wrote: »

Ugh, so it feels like if you have had a loan for a number of years it is really rather pointless to try and pay it off earlier, because in terms of interest paid the damage has already been done.

Well no, because you need to look at the interest that you would keep paying in the future, too.

If the principal outstanding has hardly changed, then that suggets that you still have a lot of the loan to run, so you are saving a lot of future interest.

sdellboy

When I have tried, in the past, to pay off a loan early I found out the interest was front loaded so paying it off early made no difference to the total in the end.