Some loans come with a facility that allows you to make extra repayments if you have the capacity. If you’re not sure how useful or otherwise this could be, it’s worth doing a little checking up before you commit to a specific loan arrangement.
What are extra repayments?
When you sign your loan agreement with your Australian lender of choice, you are pledging to repay your borrowing at a specific rate every week, fortnight or month, depending on your loan contract. The same applies if you have a credit card. Your lender sets the minimum amount you have to repay. However, at times you may have the option to pay a little bit extra if you are able to do so. This loan feature is called 'extra repayments'.
Why do people make extra repayments?
There are a number of reasons why you might want to make extra loan repayments.
- If you regularly pay even just a little bit extra on your loan you may discover that it can make a huge difference in the long run, and that your debt is paid off more quickly. This is because as you reduce the amount you owe you are also reducing the amount of interest that is calculated on the outstanding balance.
- If your chosen loan agreement allows you to make extra repayments without any additional penalty, doing so is likely to be of benefit to you at or before the end of the repayment period.
What are the main features?
Lenders set a minimum loan repayment value based on charging you interest on the outstanding balance at each stage for the lifetime of your loan. So, often the largest portion of your early repayments will be to offset interest rather than repay the capital or principal you have borrowed. Making extra repayments provides you with an option to cover the required interest, repay some of the capital and then repay more of the capital because you are paying an additional amount.
Each time you repay a little more of the capital amount you are effectively reducing the amount of interest the lender will be able to charge in the future. This means that the balance between interest and capital repaid changes in your favour during the loan period.
What are the pros and cons of extra repayments?
Most lenders will provide you with a helpful calculator on their website that indicates the difference it can make to overpay loan amounts occasionally or regularly. Generally where an extra repayment feature is available there is an opportunity to overpay on loans at both fixed and variable rates, although always check with your lender if you have a fixed rate arrangement as some may charge additional fees for the privilege. Calculators can demonstrate how much interest you could save and how much time you could save in terms of the length of the repayment period.
What you need to look out for is whether or not your lender will impose a penalty if you pay off your debt earlier than expected. This is important as if this is a significant amount it may not be worth making extra loan repayments.