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Loan Repayment

What is Loan Repayment?

Businesses which availed of loans are well aware of loan repayment. It’s simply the process of repaying the loan as per the terms agreed upon during the loan disbursal. Loan repayment involves payment of the principal and the interest accrued during the course of time. Repaying the loan in easy monthly instalments or EMIs is one of the most popular and mostly used repayment methods. However, many such repayment methods are available to make it easy for borrowers to choose the one that suits their repaying ability.

Different Types of Loan Repayment Methods

EMIs or Equated Monthly Installments

EMI is a method of repaying a loan or debt in equal monthly instalments. Banks calculate the EMI by adding the principal amount and the interest rate charged on the outstanding balance and dividing this amount by the number of months in the loan or repayment tenure. EMI is a popular option because it allows borrowers to spread their payments over a longer period, making the repayment more manageable.

When you take a loan, the lender will provide a repayment schedule that includes the EMI amount, the number of instalments, and the repayment tenure. The EMI amount remains constant throughout the repayment period, but the proportion of principal and interest in each instalment changes over time.

Bullet Loan Repayment

In this repayment plan borrower pays off the principal amount in one lump sum payment, also known as a “bullet payment,” at the end of the loan tenure. However, he continues to make regular interest payments during the loan term, which is typically shorter than the repayment period of a traditional loan.

Bullet loan repayments are commonly used in commercial and real estate loans where the borrower expects to have a large sum of money available to repay the loan at the end of the term, such as from the sale of a property or from other investments.

Balloon Loan Repayment

In this repayment method, the borrower makes smaller periodic payments (such as monthly or quarterly) over the course of the loan term, followed by a large lump sum payment, also known as the ‘balloon payment’, at the end of the term.

In a balloon repayment plan, the borrower typically pays off only the interest on the loan during the term, and the principal amount remains unpaid until the final balloon payment is due. Balloon payments are commonly used in certain types of loans, such as mortgages and commercial loans, where the borrower anticipates having a large sum of money available at the end of the term to make the final payment.

Balloon repayment plans can be advantageous for borrowers with limited cash flow in the short term but anticipate a larger cash inflow in the future, such as from selling a property or a business asset.

Loan Balance Transfer

Loan Balance transfer is a process of transferring the outstanding balance of an existing business loan to a new bank, which offers a lower interest rate or better terms. Choosing a lender with a low-interest rate saves money over the long term.

The new lender may charge a processing fee or other charges for the loan balance transfer, which the borrower should factor into their calculations when determining whether it is worth transferring their business loan balance.

Accelerated Loan Repayment

This is a method of repaying a loan faster than the originally scheduled payment plan. In this method, the borrower pays more than the minimum required payment each month or makes additional payments beyond the regular payment schedule to reduce the loan’s overall term and the amount of interest paid.

The accelerated loan repayment method reduces the total amount of interest paid over the life of the loan, resulting in significant cost savings. It can help borrowers pay off their debt faster, allowing them to become debt-free sooner and freeing up cash flow for other financial goals.

Loan Prepayment

Loan prepayment or pre-closure is the act of paying off a loan partially or in full before the scheduled repayment date. There are several ways to prepay a loan. One approach is to make additional payments beyond the regular monthly payments, which can reduce the overall term of the loan and the amount of interest paid. Another approach is to make a lump-sum payment to pay off the entire loan balance at once.

Prepaying a loan saves interest costs, improves the borrower’s credit score and frees up cash flow for other business plans. Loan pre-closure might attract some charges depending on the lender.

Partial Loan Payment

As the name suggests, partial loan payment refers to making a payment that is less than the full amount due on a loan payment. This can happen when a borrower is unable to make the full payment due to financial constraints or other reasons.

When a borrower makes a partial payment on a loan, it is usually applied first to any outstanding fees or interest and then to the principal amount of the loan. The remaining unpaid balance will continue to accrue interest until it is fully paid off.

Fully Amortising Payments

A fully amortising payment is a loan payment that consists of both principal and interest, where each payment is calculated to pay off the entire loan balance by the end of the loan term. This means that with each payment, a portion goes towards the interest owed on loan, while the rest goes towards reducing the principal amount owed.

Fully amortising payments are commonly used in fixed-rate mortgage loans, where the interest rate and payment amount are fixed for the duration of the loan term. With each payment, the borrower is reducing the principal amount owed, which means that the interest charged on the remaining balance decreases over time.

A fully amortised payment ensures that the borrower will pay off the loan balance by the end of the loan term as long as all payments are made on time. It also helps to provide borrowers with a predictable payment schedule, as the payment amount is fixed for the duration of the loan term.

Graduated Payments

In graduated payments, loan repayments start off lower and gradually increase over time. The purpose of a graduated payment plan is to make the initial payments more affordable for the borrower, with the expectation that their income will increase over time, allowing them to make higher payments in the future.

In a graduated payment plan, the borrower typically starts with lower monthly payments, which gradually increase over a predetermined period. This repayment method helps borrowers who are just starting out in their business and may have limited income initially.

However, it is important to note that this repayment method may result in higher total interest costs over the life of the loan, as the lower initial payments mean that less of the principal is being paid off.

Interest-only Loan Repayment

In this repayment method, the borrower only pays the interest on the loan for a specified period, typically between 5 to 10 years. This means that during the interest-only period, the borrower’s payments only cover the interest on the loan and do not reduce the principal amount owed.

In this method, the borrower can benefit from lower monthly payments during the initial period, which can be helpful in managing cash flow during the initial years of a loan. However, it is important to note that interest-only loans can result in higher total interest costs over the life of the loan. In addition, once the interest-only period is over, the borrower will need to make larger payments to cover both the principal and the interest on the loan.

FAQs on Loan Repayment

Which loan repayment method is the most cost-effective?

The most cost-effective loan repayment method depends on the type of loan and your repayment capability. A fully amortising loan will generally result in the lowest overall interest costs, but a graduated payment plan or an interest-only loan may be more affordable in the short term. An accelerated loan repayment plan can also be cost-effective, as it can reduce the total interest paid over the life of the loan.

Can I change my loan repayment method after I've started making payments?

It depends on your lender, as some banks may allow you to change your repayment method while others may not.

What happens if I can't make my loan repayments?

If you can't make your loan payments, you may have to face late fees, penalties, and damage to your credit score. It's better to speak with your lender and get some temporary forbearance or a modification to your repayment plan.

How can I repay my loan faster?

Several ways to pay off a loan faster include making extra payments, increasing your monthly payment amount, or making lump sum payments. You can also consider an accelerated loan repayment plan or refinancing to a shorter-term loan with a lower interest rate.

Can I opt for a balance transfer to change my repayment method?

When you opt for a balance transfer, it’s like taking a new loan with different terms and repayment methods. Make sure to consider the costs associated with a balance transfer to ensure the new loan will benefit you in the long run.

How is an interest-only loan different from a fully amortised loan?

In an interest-only loan, the borrower only pays the interest on the loan for a specified period, typically between 5 to 10 years. On the other hand, a fully amortising loan requires the borrower to make payments that cover both the principal and the interest, resulting in the loan being paid off in full by the end of the tenure.

What is negative amortisation?

Negative amortisation occurs when the borrower's loan payment is less than the interest on the loan, increasing the loan balance over time. This can occur in loans with adjustable interest rates or in loans with payments that are not sufficient to cover the full interest charge.