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Is It Actually Best Practice to Overpay on a Loan?

Is It Actually Best Practice to Overpay on a Loan?

Should You Overpay on Your Loans?

Overpaying on your loan might seem like a smart thing to do, especially if you have the money available. Why wouldn’t you make extra payments to bring down your monthly payments or the overall cost?

In certain cases, this is absolutely the way forward. Making overpayments can, in some cases, obviously end up saving you a fair bit of money. This is especially true for things like credit cards and mortgages, or longer term loans. However, this does depend on the agreement with your lender, as repaying early can potentially result in additional costs.

Some lenders will charge an early payment charge if you clear your loan early, which might end up costing you more than if you were to pay by the agreed date. From the outset, make sure that you are aware of any fees or costs involved, as it could end up surprising you later down the line.

a chap making notes on paying his loan early

Let’s take a look at some different loan options to compare the pros and cons of making early payments:

Payday Loans

Payday Loans, by nature, are short-term advances designed to be completely cleared before your next payday. They tend to have a much higher interest rate than other forms of credit, so, in most cases it would be wise to clear the loan as soon as possible.

Depending on your agreement, you might be incurring daily interest charges or a set amount of interest. You should find out from the lender whether there are any costs or charges involved if you were to pay before the due date. If not, and it actually works out better for you, make the payment as soon as it is realistically possible.

Personal Loans

Personal loans are generally a longer term solution to personal borrowing, so they will usually have a much lower APR. This gives the bank or lender more of an incentive to add early repayment costs. Obviously, this will vary from lender to lender, so you should read the terms and conditions in full before you commit to an extra payment.

Pretty much any direct loan lender allows you to overpay or pay early, but – clearing the loan in full before the agreed date might incur additional fees. The key here is, to work out whether these fees will cost less than a full term’s worth of interest. Furthermore, you could be lucky enough to be in an agreement where you can make extra payments with no top up fees/early repayment fees (which some lenders offer to sweeten your potential custom).

Credit Cards

Credit cards work differently to other types of borrowing, in which you have a minimum monthly repayment and a maximum account balance. The minimum payment will change based on the outstanding balance, which you can reduce or add to at any time.

It’s recommended to pay off as much as possible on your credit card on a monthly basis. Thus meaning, you won’t receive any additional charges for clearing your credit card balance early, as it is an open account. There is no ‘final’ due date, as you can dip in and out and use the card whenever you want, for as long as you need it.

a wooden table with a pen flowers and paper on

The Main Takeaway

Some of these situations are quite difficult to work out whether you should be making overpayments or not. However, the main takeaway here is – if there are early repayment fees involved, you should essentially work out which option will end up costing you more – a longer period of incurring interest charges, or the one-off early repayment fee. It will differ for one individual to the next, based on what the fees are and how long you have left on the loan.

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