How good would it have been had there been no obligation to
repay the loan or mortgage? This is what most people think when
required to make the monthly repayments. But try as much as they
can, they are never able to change the situation.
The borrower has to cut his monthly expenses to provide for the
repayment. The amount to be repaid includes the principal amount
of the loan and the interest calculated based on the rate of
interest prevailing in the market. This is the traditional
method of repayment.
The loan amount is broken into a number of small parts for an
easy repayment. The number of parts corresponds with the term of
repayment. Thus, if the loan or mortgage is to be repaid in a
period of five years, the number of equal parts of the loan will
be 60. The repayments are to be made on a monthly or quarterly
basis.
An improvement in the method above was made to reduce the burden
of a borrower. The borrower is required to pay regular monthly
installments as in the earlier method. After a certain number of
installments the borrower can pay the remaining balance of the
loan with a single balloon payment.
An alternative of the traditional method of repayment is an
interest only repayment. In this type of repayment, the borrower
is required to pay only the interest. At the end of the term of
repayment or any particular time period desired by the borrower,
the balance on the loan is repaid in full.
The monthly repayment in the interest only method is far lesser
than in the former method. This is because the monthly repayment
in case of the former includes both principal and interest. It
is on this count that people prefer to repay through the
interest only method. However, this method of repayment
increases the cost of the loan.
A repayment vehicle is created to repay the loan or mortgage at
the end of the term of repayment. The borrower is required to
pay a monthly figure into the repayment vehicle.
Pensions, endowment policies, and individual savings account are
the most important repayment vehicles. Pensions are widely used
for repayment of the loan or mortgage amount. An added advantage
in case of the pension policy is that the employer pays half of
the amount of pensions. Thus effectively speaking, the borrower
spends only half the amount in the repayment. Being tax free,
these repayment vehicles offer a cheap means of repayment.
Another method of repayment which is not very popular but can be
used for short term loans is the payment of principal and
interest in one installment. This is helpful for people who need
funds during contingencies. They can pay off the loan when the
situation improves. An advantage of this type of loan is that
the interest cost is lesser.
If you find that the methods discussed above are rigid as to the
amount of monthly installments and the mode of repayment, then
the equal principal payments will be helpful. The interest in
this method is calculated in declining balance method. Thus, it
means that the repayments change every month according to the
reduced balance.
Early or premature repayment of the loan or mortgage (if
permitted by the lender) is another repayment method. Before
signing any documents for loans and mortgages, one must see
properly if the lender does not prohibit early repayment with a
penalty clause. Refinancing a loan or remortgaging a mortgage
can help customers get rebate for early repayment. These
transfer the loan or mortgage to another lender. So the
borrowers can benefit from a lower rate of interest and a rebate
for early repayment.
Whatever be the method chosen, the ultimate end of it would be
the repayment of the loan or mortgage in full. All forms of
repayment have their respective pros and cons. A perfect match
between the pros and cons of the repayment methods and the
individual financial condition must be established in order to
derive the best method of repayment. There is not always an easy
return from a particular method of repayment. A wrong repayment
method can be precarious to ones financial health.
