Loan repayment involves returning the amount of money borrowed from a lender plus any interest accrued on the loan. This can be done through regular monthly payments or an amortization schedule.
The most common method of loan repayment is through EMIs (Equated Monthly Instalments) where each payment includes both principal and interest. However, there are ways to speed up this process and save a lot of money in the long run.
Paying Off Your High-Interest Loan First
High-interest debt can be difficult to pay off, owing to sky-high interest rates that quickly build up over time. High-risk loans, such as payday, personal and title, often have interest rates of 200% or higher — far higher than traditional credit cards and other financial products.
Depending on the borrower’s income and credit history, the cost of repaying these loans can be prohibitive, impacting financial goals such as saving for a home or retirement. Additionally, defaulting on these loans can have significant consequences for borrowers, including a negative impact on credit scores and garnished wages.
One way to help combat this issue is to reduce borrowing by lowering credit card utilization, building an emergency fund and avoiding excessive borrowing. Borrowers can also explore alternative financing options, such as credit unions and community development financial institutions, which may offer more favorable terms than mainstream lenders for borrowers with limited credit history or those who have experienced financial difficulties.
For those that still have significant debt, paying off the highest interest debt first can save borrowers money and help them to get back on track with their finances. This strategy is known as the debt avalanche method of repayment and is a popular approach for many borrowers. Others, however, prefer to prioritize the debts that have the lowest balances owed, using the snowball method of debt reduction.
Making One Extra Payment a Year
When you make a payment, a portion goes into an escrow account to pay homeowners insurance and property taxes and the rest reduces your loan principal. When you add one extra payment each year to chip away at the balance, you will shorten your loan term and save thousands in interest payments. Putting one extra payment a year into your loan could be as easy as using a tax refund or work bonus. However, if you do this, be sure to check with your lender to ensure they do not charge prepayment fees. They are typically prohibited from charging them under federal law.
Making Bi-Weekly Payments
One popular strategy that homeowners and other borrowers use to pay down their principal faster is to make biweekly payments. This is accomplished by dividing the monthly payment by two, and then making half payments every other month. This approach results in 26 total payments per year, and it significantly shortens the loan term. It also saves considerable amounts of interest, and it enables borrowers to build equity in their homes sooner.
However, borrowers should be aware that some lenders aren’t structured to accommodate a biweekly payment schedule and will still calculate interest based on the full monthly payment amount. Also, if you’re using a third party service to handle your biweekly payments, it’s important to confirm that the entire amount of each payment goes directly toward the principal balance. Some of these services charge fees that could eat into the benefits of this method.
Another drawback of making biweekly payments is that they may leave you with less money to cover other household expenses, which can be a challenge for borrowers living on a fixed income. It’s also a good idea to speak with your lender before switching to a biweekly payment plan to ensure that they will accept the change and won’t charge any fees to process the additional payments. Also, be sure to ask about any autopay discounts that you might miss out on by going with a biweekly payment option.
Making Monthly Payments
Lenders calculate your monthly loan payment to ensure that you pay off your debt within a set amount of time. The formula varies depending on the type of loan you have and a few other factors. These include the principal, interest rate and loan term.
The loan principal is the lump sum of money that you receive from a lender, while the interest rate is the percentage of the loan you owe each month. Your lender will then add this to the principal to determine how much your monthly payments are. The longer the term of the loan, the more you will have to pay each month in interest.
Knowing how to make these calculations can help you figure out whether a particular loan will fit into your budget. Additionally, it can help you save by making extra payments or reducing your total amount borrowed.
If you’re not sure how to make these calculations, we have a simplified loan payment calculator that can help you. While this doesn’t replace the process of calculating your monthly payments, it can provide you with an estimate of how much your repayment plan might cost. Having this information can help you make better decisions about borrowing and help you avoid the risk of missing payments, which can negatively impact your credit score.