Repaying a loan ahead of time: is it better to reduce installment or term?

The economic situation of a person can change a lot from one month to another. It may be that last month we needed a credit and that this month we have obtained a bonus at work, an extra pay or a lottery prize that solves part of the problem. In this situation, the reasonable thing is to want to use the money to pay back, if not all, part of the loan. But what is more expensive, reduce the monthly fee or pay the same as before but for less time?

From the HelpMyCash.com comparator they are very clear: "Reducing the term is what saves the most money, since time is the factor that increases interest the most".

Example of early repayment on a loan

Being able to use extra money to pay the mortgage or a loan ahead of time reduces the interest to be paid by up to a third, but what saves more money, paying less each month or reducing the number of installments?

Let's imagine that we have been granted a loan of 10,000 euros for 5 years, with an interest of 10% APR. This means that, for 60 months, we will pay a fee of 212.47 euros and, in total, in 5 years we will end up paying the bank 12,748 euros (2,748 euros of interest). However, as soon as we ask for the loan, we have an unexpected entry of 3,000 euros with which we want to repay part of the loan. In this situation, we have two options.

1. Reduce fee . This means continuing to pay for 5 years but much less every month. The fee would go from 212.47 euros to 148.73 euros, and the total would go from 12,748 euros to 11,924 euros. We would be reducing interest by 43% (from 2,748 to 1,924 euros).
2. Reduce term . We would maintain approximately the same quota but for many fewer months. For example, we could go from 5 to 3 years, the fee would go from 212.47 euros to 225.87 euros and the total would go from 12,748 euros to 11,131 euros. We would be reducing interest by 142% (from 2,748 to 1,131 euros).

In mortgages, paying earlier means more savings

Thus, it seems clear that reducing the term can save us three times as much interest as reducing the fee. “And the conclusion is the same if we talk about a mortgage”, they comment from HelpMyCash , “even the savings are more pronounced, since the higher the debt, the greater the savings when repaying early. For example, a mortgage with 125,000 euros pending for 25 years at 3% of which we amortize 20,000 euros, we will pay 52,829 euros in interest to 26,208 euros reducing the installment (101% less) and 18,563 euros reducing the term (185% less).
However, from the comparator they call for caution: “We must find a balance, that is, not to amortize so much that we are left with nothing saved for possible unforeseen events or to try to pay so much per month (to reduce the term to the maximum) that we drown In day to day".

 

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