Early Repayment Penalties

Posted by Ben Ryland in Personal Finance on 3 January 2017 - Ben is a Senior Credit Analyst at checkmyfile.

What is an early repayment penalty?

The amount differs from lender to lender but in essence in order to complete a credit agreement early, the lender will charge an early repayment fee/penalty. For example, if you were to pay off a loan that had a 5 year term early by settling the agreement in full in year 4, the lender will charge an early repayment fee to end the credit agreement before it is due.

While it is not a blanket rule, most lenders will charge several months interest as the penalty and the earlier in the agreement that you settle, the higher this charge will likely be. This is mainly as the earlier in a credit agreement that you terminate the more the interest makes up the repayments.

Early repayment penalties are difficult to avoid as most credit agreements have them included in the terms of the agreement. While there are some providers who do not include this charge it is important to check for terms including ‘early repayment penalty/charge’, ‘early redemption fee/charge’ and sometimes seen as a ‘financial charge’.

By looking out for these common terms, you can avoid these early repayment penalties by choosing credit agreements where these charges do not apply. With loan comparison tools widely available you can compare loans easily where early repayment charges do not apply.

Consolidating debts into a debt consolidation loan is one of the most common instances where a credit agreement is ended early, and many go for these specific types of loan without realising the potentially high cost of ending the credit accounts which are being consolidated. These charges can begin to stack up making the consolidation process much more expensive than you may have realised.

These early repayment charges are included by lenders as when the credit agreement (loan or mortgage most commonly) is set up, the lender is providing the credit for a set period of time. If this period is reduced due to an early settlement, the repayment penalty compensates for the lender’s costs as a result of the credit agreement ending sooner than originally agreed.

Some lenders may offer exceptions to the early repayment fee, with several mortgage providers offering customers a certain percentage of over-payment which can be made without incurring the early repayment charge.

As you apply for credit borrowed over a set time, it is vital to familiarise yourself with these financial penalties. Circumstances can change where you are in a position to clear an agreement early, but don’t be caught out by a high early repayment penalty to do so.

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