Financial Freedom Quick Tip #16: Read your loan’s fine-print!
Today I read an excellent post about “snowflaking” on Mrs. Micah’s blog.
Apart from the fact that I love the idea (and that it worked for me, even though I did not know I was snowflaking at the time), the author also explained some very valuable things you should watch out for when you want to settle your loans early.
The main points I’d like to share is that your loan agreement may allow your credit granter to charge you penalty fees for settling early, and he may also wiggle additional payments to be in his best interest, instead of yours!
E.g. if you pay in an additional payment, your credit granter may decide to not take the amount off the principle outstanding amount, but rather treat it as an “early payment” for the next month. In effect, you’re then lending him money, at no interest, and also not saving any interest on your loan!
Unfortunately, many loan agreements are structured in such a way that these things are legal for the credit granter. Sometimes it may be better for you to not make additional payments towards your loan, but to rather save them up elsewhere (where you do earn interest), and then, once you’ve saved enough money, pay the whole loan off in one go.
In summary: if you’re trying to pay off your debt early, make sure you understand your loan agreements. Then choose the best way for you to proceed, even if it means you have to be creative about it.
This tip is part of the Financial Freedom Quick Tips series. If you want to receive a notice every time a new quick tip is published, you can subscribe to Liberta.
August 2nd, 2008 at 04:12 pm
Thanks for mentioning it. I had a friend contact me after reading the post, he’d done all the “right” things about asking whether there were prepayment penalties (no), getting the loan through the bank instead of the dealership, etc. But he just assumed that extra payments would go to principal. It’s a new loan, so he hasn’t lost much if he sent in extra, but it’ll be useful for him to find this out since he plans to pay it off in half the time or less…could save $1000 or more in interest.