This article was updated on 10 September, 2021
Should you receive an inheritance or win the lottery, you might consider paying off the personal loan you took out to consolidate your debt. You may, however, soon discover that you will have to pay extra because of early settlement penalties.
Tip: If you haven't consolidated your debt yet, click here for a free debt assessment.
According to Sasha Knott, former CEO of Switch2 Credit Life, the National Credit Act states that penalties for early settlement do apply for large debts.
“The Act categorises large debt as anything over R250,000, or a home loan. If the consumer wants to settle a small personal loan, i.e., up to R15,000, or an intermediate loan, i.e., between R15,001 and R249,999, no penalties should apply,” Knott explains.
The below table illustrates when early settlement penalties apply.
|
|
No penalty |
Penalty |
|
R250,000 > |
|
X |
|
R15,001 – 249,999 |
X |
|
|
R15,000 < |
X |
|
Knott points out that these penalties may not exceed the value of three months’ worth of interest. In other words, if you owe more than R250,000, and your monthly payment is R7,500 - of which 25% is interest - your service provider would not be able to charge you more than R4,500 as an early settlement penalty.
“This amount can also decrease if the consumer gives notice and advises the debtor of their intention to settle early, although this notice is not obligatory. But I would check your loan agreement and discuss this with your credit provider,” says Knott.
Early settlement penalties offer compensation to the lender, who was contractually promised monthly payments for a set amount of time. To make up for this loss of “guaranteed” income, the consumer needs to pay-off the lender, and a compensation clause is usually included in the credit agreement.
“Should a consumer be considering an early settlement on a large debt, they are well within their rights to request a no-obligation settlement quote indicating any penalties that may be due on settlement,” she adds.
READ MORE: Is good debt a good reason to take out a personal loan?
Reasons to consider early settlement
The main reason to consider paying your loan off early is to minimise the exorbitant expenses that come with the accompanying interest payments.
However, Knott points out that if consumers are interested in maintaining a good credit score, they should consider keeping the loan open and managing it carefully with their newly-acquired lump sum. Doing this will lead to a great credit score and, as a result, lower your future interest rates on new loans.
“Remember that very few South African credit agreements can be entered without a good credit score. No credit means no score,” says Knott.
“When you’re ready to settle your personal loan, you should consider which will carry the lowest penalties, and which should be kept open to maintain a good credit record,” she adds.
Knott highlights that personal loans are more affordable than credit card debt.
“I would advise consumers to pay off high-interest credit card debt first, before turning their attention to personal loans,” she says.
Are you in need of a personal loan? Click here to apply for one today.