When you receive an inheritance or win the lottery, you might consider paying off the personal loan you took out to consolidate your debt. But you may quickly find out you will have to pay more because of early settlement penalties. 

According to Sasha Knott, 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 (up to R15 000) or intermediate (between R15 001 and R249 999) personal loan early, 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

 

 

She points out that these penalties may not exceed the value of three months’ interest. In other words, if you owed more than R250 000 with a monthly payment of R7 500 (of which 25% consisted on 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 a notice period 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. 

“It is understandable that settling a contractual amount early results in interest income losses for the lender. For this reason, the “compensation” clause is usually included in the credit agreement,” says Knott.

“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 become due on settlement,” she adds. 

The main reason to consider paying your loan off early is to prevent the exorbitant expenses that come with the accompanying interest payments. By paying your loan off early, several interest payments can be avoided.

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 on personal loans,” she says.