Early repayment: lower the payment or the term?
The two ways to repay early, how much each saves, and when the lower payment is the sensible choice.
Published
Two options, one action
When you repay part of a loan early, the balance falls at once. The bank then asks what you want to keep:
- the payment, in which case the loan's term gets shorter;
- the term, in which case the monthly payment falls.
Both save interest, but not the same amount.
An example
Take a loan with a balance of 200,000 lei, a 6.5% rate and 20 years left. The payment is about 1,491 lei. You repay 20,000 lei early.
If you shorten the term, the payment stays 1,491 lei but you finish in 16 years and 5 months, 3 years and 7 months sooner. You save about 45,000 lei in interest.
If you lower the payment, you pay 1,342 lei a month, 149 lei less, for the same 20 years. You save about 15,800 lei in interest.
The difference comes from time: in the first option you hold the borrowed money for several years less.
When lowering the payment makes sense
Shortening the term wins on interest, but it isn't always the right choice. A lower payment makes sense if:
- your monthly budget is tight and you want a safety margin;
- you expect your income to drop;
- you want to invest or save the monthly difference.
There is also a middle way: lower the payment but keep paying the old amount, as monthly early repayments. You get almost the same result as shortening the term and keep the freedom to drop back to the lower payment.
Fees
On variable-rate loans in Romania, early repayment carries no fee. On fixed-rate loans the fee is at most 1% of the amount repaid.
Put your own figures into the early repayment calculator and compare the two options.