Loan repayments are not as simple as they seem. There is much to be read between the lines and many choices one can make to optimise the interest rate payment and reduce the overall cost of the loan. From overdraft costs to seemingly bizarre early repayment fee, there are a million ways one might find their interest payments increasing.
The answer to getting out of this dilemma is getting the right information to make the right decision. Here, we’ve listed some of the things which could decrease your interest payments:
Reconsider That Decision To Consolidate Your Debt
Debt consolidation seems like a good idea when you’re already down in the dumps. The option is offered to those who have multiple loans and are having difficulty repaying them.
Consolidation is an act via which the remainder of all the loans is combined into one. A new interest rate – taking into account all the different interest rates on the various loans and adding weight to them – is calculated to define your new payment scheme.
So far, so good, right? Maybe not. Debt consolidation is advertised as a panacea to the multiple debts vortex, but in the long term, the repayments, even if the interest rate is lower, can burn a hole in your pocket.
Debts are usually consolidated against houses, and if even the consolidated debt goes unpaid, your house might be foreclosed.
Keep the Overdraft in Check
A loan account is usually equipped with an overdraft facility that the borrower can use. It is advised that this overdraft facility may only be used in dire need or when all other alternatives have been exhausted.
The reason for saying this is that account overdrafts draw an exorbitant interest rate. This leads to an enormous increase in the total interest rate and the amount you’ll ultimately have to pay to the bank.
There are many measures one can take to reduce overdraft costs. The obvious way is to ask for an authorised overdraft. An authorised overdraft is an overdraft limit set by the bank, crossing which the bank would take strict actions against the borrower.
Recently, many banks have begun charging a flat fee to a specific limit or have included ‘buffer zones’ for small interest-free overdraft withdrawals for customers. One could also apply to one of the several 0% overdraft programmes run by banks.
Credit Score Affects the Interest Rate
The credit score is perhaps the most vital piece of information on your loan application, with the income statement running a close second. The credit score is a quantified measure of your credit-worthiness and defines the limit to which the bank can trust you with its money.
The simple rule is this: Lower the credit score, the more challenging it is to get a loan. A lower credit score than average increases the risk that the bank is taking, and therefore, to ensure safety, it might be that the bank ups the interest rate chargeable to your loan amount.
All the necessary steps must be taken towards improving your credit score if it is below the accepted average. This includes timely repayment of past loans and dues, if any, and keeping the credit card expenditure way below the limit for a considerable amount of time.
Loan Repayment Via Credit Card
Sounds a little oxymoron-ish, doesn’t it? Paying off a loan by taking another one – as silly as it may sound, once the logic behind it is expounded, it may sound like a sweet deal to you.
Credit cardholders with an impeccable or near-impeccable credit score are the customers on whom banks can trust. Therefore, it can be expected that the bank offers them a low interest or entirely interest-free window on their credit card borrowing. This borrowing is directly transferred to the card holder’s bank account and is popularly known as a ‘super balance transfer’.
If applicable, the said balance transfer can then be used to repay a part of the existing debt or overdraft costs. The caveat is that super balance transfers are accompanied by fee payment. The borrower can make a quick, back-of-the-napkin comparison to determine if the deal is worth taking or not.
Opting for a Shorter Tenure Loan
A shorter loan term is another way to lessen your interest payments, or rather, saving on your interest payments. By fixing the interest rate and only reducing the period over which the loan has to be repaid, the loan’s equated monthly instalments are affected. These instalments, as time is squeezed out, balloon a bit.
However, as EMIs grow, the loan is repaid faster, and the effective interest payment is lower than that of the same loan and interest rate over a more extended period.
One of the caveats of short-term loans is the increased burden of monthly payments. Depending on your financial situation, this increase might be a benign or a cruel blow to your savings. It is advised that you compute the actual savings you’ll get on the interest payments, if any, and weigh whether the risk is worth enough to take.
Get the Interest Calculation Method Right
Often, people complain that their interest payments are higher than what they had in mind regarding the interest rate. That could happen because of discrepancies in the interest payment calculation method that the bank applied.
The lender will usually opt either for a flat rate or a reducing interest rate. As the name suggests, the flat rate is calculated over the total principal amount of the loan, and interest payments are uniformly distributed over the whole tenure of the loan.
Reducing interest rate loan repayments, on the other hand, are calculated on the remainder of the principal amount with each instalment. Therefore, one will gradually find the interest payment shrinking in size over the loan tenure.
Early Repayment Fee
You might be thinking that you’ll be better off the sooner you repay your loan. That is correct. But who’s hurt by this early repayment of the loan? The lender.
Lenders hope to make money out of the interest they charge to the borrower, and this profit, after reducing all the costs from loans, is carefully spread over the tenure of the loan. The lender doesn’t want to stretch the repayment tenure to wrangle more and more profit from the borrower but has to lend it for enough time to make a living.
This is why you might face a minor setback if you come up to the bank loaded with the total loan repayment. Firstly, not all banks are enthusiastic apropos to early loan repayments. Secondly, even if they somehow agree to it, you might find yourself paying an additional fee for repaying the lender before the tenure’s up.