`Early repayment charge` – what is it?

23 May 2008

If you’re thinking about repaying a loan early, it’s important to understand how an ‘early repayment charge’ works.

When you borrow money, the lender anticipates earning interest over a fixed period of time. Many lenders will demand an early repayment charge (or ‘redemption penalty’) if you pay a loan back early, because they won’t be getting as much money back in interest as they originally anticipated.

Certain types of credit – mostly mortgages and some long-term loans – usually come with early repayment charges.

With many loans, the interest is ‘front-loaded’, meaning all the interest is immediately added to the actual loan amount. If you repay the loan early, the lender may give you a partial rebate on the front-loaded interest, depending on how long you have owed the money.

More flexible sources of borrowing such as credit cards, store cards and overdrafts will not come with these early repayment charges as there are no set rules on how or when the money will be repaid.

Early repayment charges & debt consolidation
With many loans, you will only have to pay an early repayment charge if you pay it off in the first few months or years (usually during the period for which the interest is fixed or discounted).

Sometimes it is a good idea to wait until then before you pay the loan off – but not always. Paying off your debts with a consolidation loan, for example, might reduce your monthly payments by enough to make paying an early repayment charge worthwhile.

But before making any decisions, it’s advisable to seek professional debt advice from an expert. There are several other options for people struggling with debt – debt management plans, IVAs (Individual Voluntary Arrangements), Trust Deeds for Scottish residents, etc. – and an expert debt adviser can help you do the maths and discuss the best option for you.

Remember, some debt solutions do not work by clearing existing debts straight away – and no early repayment means no early repayment charge.

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