About 7 out of 10 of us pay off our personal loans early, yet this cost us a whopping third of a billion pounds last year in penalties. However, these charges may soon vanish.
Have you ever had a personal loan that you decided to pay off early? Were you shocked by the interest penalty you were charged for doing this? Well, you're in good company because, according to leading internet bank
Egg
(
LSE: EGG)
, UK borrowers were charged an astonishing £332 million to settle loans early last year.
Egg claims that 70% of loans are paid off early but, in spite of this, four out of five lenders penalise borrowers for early settlement. Typically, this adds £80 (1%) to the cost of a typical loan. The majority of lenders - including the usual high street suspects - charge two months' interest for early settlement. However, a few - including Cahoot, Egg, Nationwide BS and Virgin Money - charge no penalties whatsoever.
Worse still, four out of five borrowers aren't aware of these penalties, leading to accusations that lenders are burying this information in the jargon in their small print. Egg is calling on the Department of Trade and Industry to ban these fines in its wide-ranging review of consumer credit, which the DTI is expected to publish shortly.
We Fools are opposed to early-settlement penalties, not only because they discourage borrowers from switching to cheaper loans, but also because they are not widely publicised. Furthermore, the Rule of 78 (the complex formula that lenders must use when calculating interest penalties) is far too complicated and can only be appreciated by the mathematically minded.
The banks argue that they need to penalise early repayers to recoup the costs of setting up and closing loans. This is nonsense, as a typical unsecured personal loan charges interest at 14.85% APR, while the base rate is scarcely a quarter of this at 3.75%. Thus, lending margins are easily high enough to support the costs of early settlement without extra excessive penalties.
So, the next time you're shopping around for a personal loan, make sure you ask about early-settlement penalties and avoid those lenders that charge them. Better still, become an expert borrower with our guide to getting a better deal on your loan.
More: Beware The Hidden Costs Of Borrowing | Track down a bargain at our Personal Loan Centre.
