Understanding the Early Redemption Penalty within Your Loan

If you are like most people, the fact that you owe money to someone probably weighs heavily on your mind. As such, when you find yourself having a little extra money, you may want to send that money to your lenders. Unfortunately, this may not be as good of an idea as you think.

Not All Loans are the Same

Depending on the type of loan you have acquired, paying your loan early may actually cost you more money. This is because some lenders charge extra fees for paying of a loan before its maturity or for paying more than the predetermined loan amount. This is referred to as an early redemption penalty.

The reason for the lender including a early redemption policy within the loan paperwork is quite simple: it guarantees that the lender makes money from the loan. After all, the way the lender makes money from a loan is through the interest that you pay on the loan. If you pay the loan off early, the lender will not receive the amount of money in interest charges that it had anticipated. With an early redemption policy in place, the lender is still guaranteed to make money from the loan – even if it is paid off early.

How Much You Can Expect to Pay

The amount of money you will be expected to pay as a result of paying off your loan early will vary according to the amount you borrowed and according to the lender’s policies. At the most, you will be charged with two months worth of interest charges because the Consumer Credit Act of 2004 stipulates that this is the most a lender can charge. Therefore, the more money you borrowed, the higher your interest fees will be.

If you overpay on your regular monthly payments in order to get the loan paid off earlier, you may also be charged penalty fees for paying the loan off early. In other cases, the lender may essentially keep track of the amount of money you overpaid and will ultimately give you a “holiday” month. With a holiday month, you will be excused from making your payment for that month. While this may seem like a nice break that allows you to have some extra money for the month, this is actually the lender’s way of getting you back on track so it can make the money off the interest it anticipated receiving.

Before you sign a loan agreement, it is a good idea to ask the bank if an early redemption policy will be in place. In response to the regulations enforced by the Consumer Credit Act, many lenders no longer implement early redemption penalties. Nonetheless, if you anticipate paying the loan off early, make sure no such policy is in place or be prepared to pay the penalty fees.

If you are already committed to a loan with an early redemption penalty, you need to weigh your options carefully and do some math in order to determine how to save yourself the most money. Despite the penalty fee, it may still ultimately save you money to pay the loan off early if you are paying it off far enough in advance.