Around 70% of loan agreements are settled early but lenders are usually tied by the amount they can charge in early settlement penalties.
May 2005 saw the demise of the infamous 'Rule of 78'. And a jolly good job too. It was a most iniquitous method used by lenders to calculate the cost of redemption penalties for loans and payment protection policies.
Up to that time, the interest on loans or insurance premiums were usually 'front-loaded' and the way it worked was very similar to a repayment mortgage. In the early days of a loan, most of your monthly payments were used to pay the interest and insurance premiums rather than the loan itself. So, if you redeemed it early, you often found that you owed nearly as much as you did when you first took it out.
However, since May 2005, lenders have only been allowed to charge a month's interest towards early settlement administrative costs. They are allowed to defer the settlement date by 28 days but effectively, it means that, at most, they can only charge two months' interest if you decide to pay off your loan before the end of the agreed term.
Unfortunately, loans taken out before May 2005 aren't subject to the new calculation methods until 31st May 2007, and people with old loans lasting for more than ten years will have to wait until 2010.
Nevertheless, the reduced costs for repaying loans taken out since May 2005 do allow borrowers to save costs by switching to a cheaper loan elsewhere without being overly penalised for doing so.
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