Can I repay my loan early?


"I HAVE a little more money to put towards my personal loan repayments than I thought. Can I repay my loan early? And, if I am allowed to, should I?"

It's generally true that the quicker you pay off a personal loan, the better - and under changes to the law that came in to force in February 2011, the majority of overpayments shouldn't incur any penalty.

Those who can pay off more quickly benefit from lower total interest charges and, obviously, spend less time in debt.

However, it's not always as simple as that.

The original conditions of the loan agreement, when the borrowing was taken out and the interest rate can all affect whether it's worth making overpayments.

Click ahead to find out:

The advantages of early repayment

Everyone who takes out a personal loan has the right to make overpayments towards their debt - and in most cases, the advantage is pretty clear: paying off a debt will almost always be more beneficial than putting the cash into a savings account.

Charging more to lend money than they pay in interest on savings is how most banks make their profit, after all.

For example:

18% APR loan 6% APR loan 3% AER basic tax savings
£1,000 debt/savings over 6 months £48 £16 £11.70
£4,000 debt/savings over 1 year £399 £129 £93.60

Perhaps even more importantly, paying off debt reduces the borrower's risk; it removes the chance of letting the loan last longer than it should and continuing to accruing interest, or of defaulting or missing a repayment.

The exceptions to the rule

However, there are a few situations when paying off a loan early isn't the wisest move.

For example, people borrowing money using an extremely low APR loan, and who have other money in a high interest savings or current account could well be better off sticking to their original payment plan, rather than using savings to pay off the debt.

Early repayment penalties

The penalty attached to early loan repayments goes by many names: early repayment penalty; financial penalty; early redemption fee; redemption charge.

In principal, all these terms amount to the same thing: people with personal loans should expect to pay the provider a certain sum in order to clear their debts ahead of schedule.

But as a result of the Consumer Credit Directive, which came into force in February 2011, there are only very limited circumstances in which lenders can justify charging a borrower anything for overpaying, or even completely clearing their loan.

So anyone who took out a loan after February 2011 should continue reading. Those who borrowed money between June 2005 and January 2012 might want to jump ahead. And anyone who took out a personal loan before June 2005 should read this section.

Partial and full early settlement

Anyone making large overpayments is referred to as making a "partial early settlement"; those paying their loans off in full are making a "full early settlement".

Under the Consumer Credit Directive, almost everyone who took out loans from February 2011 onwards can make partial or full early settlements of up to £8,000 per year before being hit with penalty fees.

If there's more than a year on the loan agreement to go, once more than £8,000 has been paid off, the maximum penalty charge that can be levied is 1% of the amount being repaid early.

If that kind of overpayment is made in the final year of the credit agreement, the penalty cannot exceed 0.5%.

Someone with more than a year to go on their loan who wants to pay off more than £8,000 could therefore expect to have to pay £80 in fees - but if they split their overpayment they could reduce that fee considerably.

For example: Mrs Evans wants to make an overpayment of £9,000. If she made that overpayment all in one go, she would face fees of up to £90.

But if she split the payments, making one or two payments that total exactly £8,000, then a final payment of £1,000, she would only face a maximum fee of £10.

People wanting to make overpayments of less than £8,000 per calendar year may still be hit with a penalty fee - but only if there's something significant about the time they choose to make the repayment.

For example, interest rates on new loans are lower than they were when the loan was taken out. The lender is losing out on the interest they'd have earned from the original borrower, and they won't get as good a return on it when they re-lend it to a new customer.

Even so, the penalty rate has to be shown to be fair and objectively justified.

Loans taken out before February 2011

Anyone who took out a loan prior to the introduction of the Consumer Credit Directive is subject to slightly different rules.

Overpayments on loans made between June 2005 and February 2011 are subject to penalties of no more than two month's interest.

The earlier in the loan term the repayment is made, the higher the penalty will be; the outstanding interest is much greater.

It's essential that borrowers make precise calculations before deciding whether it's worth making an early repayment, or putting the extra money in a high interest savings or current account as mentioned above.

It's an annoying calculation - but it might cheer you up to know that for people who took out loans prior to June 2005, it was often a lot worse.

Rule of 78

In 2004, Egg, one of the few lenders at the time to offer borrowing without early redemption fees, calculated that borrowers in the UK would have to pay £332 million in fees if they paid off their loans early.

That was because, at the time, repayments were almost always covered by a nasty little law called the "rule of 78".

It's highly unlikely that anyone with a personal loan in 2015 is affected by this rule, as it was abolished in June 2005. But for the tiny minority who may still be affected - and the curious among the rest of us - this is how it worked:

Under the rule of 78, borrowers paid a set amount of interest based on both the capital and the scheduled borrowing period throughout the life of a loan.

The rule is named for the sum of 12 months (i.e. 12+11+10+9+8+7+6+5+4+3+2+1) which comes to 78.

For a one year loan, the first payment would include 12/78ths of the interest in month one. Six months in, the repayment would include 6/78ths of the interest.

The name is a bit misleading because it refers to the situation for a one-year loan; a two-year loan requires the same kind of calculation, but the sum of 24 months comes to 300 - so the first payment would include 12/300ths of the interest due. No 78s at all.

We said it was complicated.

The rule of 78 caused problems for early repayment, since the amount borrowers started off paying - which included interest calculated for the whole planned period - was slightly off-kilter.

In effect, people with these loans often had more left to pay off than they might have thought - but as we've mentioned, almost no one should be affected by this tricky little rule any more.

How to make an overpayment

The process of overpaying is the same no matter when the loan was taken out or how much the borrower wants to pay off.

The borrower must give notice of their intention to overpay. This can be done over the phone, but email and/or letter is best.

Then within 28 days of notice being given, the borrower makes the payment. It's that simple.

It, is, however, wise for people to ask for confirmation of the effect their overpayment will have. They can do this when they give notice, or when they make the payment.

The lender doesn't have to provide this information before the payment is made, but once it has they have a maximum of seven days to respond with details of the new balance, interest and so on - and any fees that have been incurred.

The main thing to do is to give notice of the overpayment, and give that notice time to be acknowledged. Otherwise the extra money can be counted as an advance payment instead, which is nowhere near as beneficial to the borrower.

My lender won't accept overpayments

All lenders are obliged by law to accept overpayments. People who've followed the steps above but have trouble with their lenders should complain.

Make the first complaint to the lender themselves, stating that they've failed to uphold the updated Consumer Credit Act, as implemented by the Consumer Credit (EU Directive) Regulations 2010.

If that doesn't work, and a lender refuses budge despite repeated efforts, take the complaint to the Financial Ombudsman Service, free of charge.

The Ombudsman takes an impartial look at all the facts of the case, and if the lender is found to have acted wrongly they could be forced to pay compensation.

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