If you have a personal loan, and you just received a bonus or an inheritance, you may be considering settling your loan in one go. However, did you know that this comes with penalties?
We have a look at the finer details of loan agreements, we consider the penalties for settling ahead of schedule, and we find out whether you should take this route.
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Understanding the fine print
According to Thomas Brennan, co-founder and CEO of Franc, personal loans are a reality for many, even more so since Covid-19 hit South Africa.
Brennan says that one way to ease financial pressure is to apply for a personal loan to tide you over. However, he suggests that before you apply for one – or even if you already have one – it’s important to understand the fine print so that you can avoid falling into a debt trap.
Personal loans can be taken out for any reason you desire, and for this reason, they are considered to be unsecured.
“Personal loan providers are allowed to charge an annual percentage rate up to the repo rate plus 21%. Assuming that the repo rate is 3.5%, that means that any personal loan charging more than 24.5% per annum is in breach of the National Credit Act (NCA),” says Brennan.
He adds that the interest rate is dependent on your credit score, and is set at the discretion of the credit provider. This is why it’s always good to shop around.
“Personal loans also include initiation and admin fees, and service charges. Therefore, it’s important to know what those charges are when you are comparing personal loan offers,” says Brennan.
“However, these fees are also regulated by the NCA. Specifically, the initiation fee can never be more than R1,050 and is calculated as R165 plus 10% of the loan amount in excess of R1,000. Besides this, the service fee cannot be more than R60 per month,” he explains.
What do early payment fees entail?
Brennan says that early payment fees are murky territory, as credit providers often say there will be a penalty if you pay off your loan early.
However, he adds that a penalty fee is not applicable to the early settlement of a small or intermediate loan agreement, which is anything that totals less than R250,000.
“If you want to settle a large credit agreement – anything that’s greater than R250,000 – the settlement amount may include an early settlement charge, which is not permitted to be more than three months’ interest. It may be less if you provide adequate notice of early settlement,” says Brennan.
According to Sbusiso Kumalo, chief marketing officer at African Bank, when a credit provider assesses an applicant’s risk profile and assigns a pricing structure, the provider has an expectation of income that will be generated from the credit agreement.
“This income is intended to offset the credit provider’s risk, cover their costs – such as salaries and funding costs – and provide some return for shareholders,” says Kumalo.
“In the event that a customer opts to exit a credit agreement early, the future revenue that they expected is lost. The intention of this clause in the NCA is to compensate the credit provider, to some extent, in the event of a customer exiting an agreement early,” he explains.
Should you settle early or not?
Brennan says that, assuming you have a large personal loan and you have the ability to pay the loan off early, there are certain do’s and don’ts that are key deciding factors.
1. Do have enough savings set aside to settle your loan
Before you commit to settling your personal loan, you should make sure that you’re not jeopardising your personal safety net, or your emergency fund.
Your emergency savings are there to protect against worst-case scenarios, like losing your job, a medical emergency, or a home repair. One rule of thumb for emergency savings is to keep enough to cover three- to six months worth of expenses.
2. Don’t jeopardise your ability to pay your monthly expenses
Your monthly expenses, such as rent, utilities, and groceries, are what you need to live. But your monthly expenses also include your other liabilities, such as your home loan, car loan, credit cards, and store cards, which you have to service.
Failure to do so can negatively impact your credit score and your ability to get future loans. Make sure you consider all of your accounts before deciding to settle your personal loan.
3. Don’t pay more in fees than you would in interest
Assuming you're exposed to an early settlement fee of three months’ interest, the simple answer is that you're better off settling early if you have more than three months’ worth of debt to service.
Basically, you need to determine whether the interest you’ll pay in the remaining months is higher than the early settlement fee. If you only have a couple of payments left and you’re looking at a fee that is more than the interest you will pay in those months, then it’s better to stick with the payment schedule.
“If you have a personal loan, or you’re thinking about applying for one, the most important thing to know is how much the loan is going to cost you overall,” says Brennan.
“A general rule of thumb is, the quicker you can pay off your loan, the less it will cost you. So be strict with yourself. Cut costs and save where you can, which will hopefully give you a little bit extra every month which you can use to pay off your loan quicker,” he recommends.
If you’re ready to take out a personal loan, fill out the form on this page.