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FIXED INTEREST LOANS: EARLY REPAYMENT COSTS 7/2/2007

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FIXED INTEREST LOANS: EARLY REPAYMENT COSTS

BE AWARE THAT FIXED INTEREST LOANS CAN INVOLVE HEAVY PENALTIES
FOR EARLY REPAYMENT OF THE LOAN
IN CERTAIN CASES THERE SHOULD BE A REFUND TO THE BORROWER
IN SOME CASES THE REFUND IS NOT PASSED ON TO THE BORROWER

It is difficult to avoid penalty interest in cases of an early payout when you have a fixed interest rate loan.

When you have taken out a ‘fixed rate’ loan of say $100,000 for 3 years at 6%, your lender commits to borrow the $100,000 at 6% (less a margin, i.e. their profit) for 3 years.

If you decide to payout the loan after only one or two years your lender remains committed to their borrowings at 6% (less their margin) for the three year period.
If they are forced to payout the balance owing earlier than the 3 years, they incur a cost which they pass on to you.

If interest rates have fallen below the original fixed rate of 6% to say 5% there will be an additional penalty (cost) to be paid.

If interest rates have increased above the original fixed rate of 6% to say 7% there should be a rebate back to you from your lender as your lender would have benefited from the transaction.

Example 1: Where interest rates have fallen below the original fixed rate:
Balance owing = $100,000.
Remaining Term = 3 years.
Original Fixed Rate = 6%
Current Interest Rate = 5%
PV’d * = the present value ( in todays’ dollars) of dollar amounts in the future.
i.e. what is $100 in 5 years time, worth, if you had it today ?

Cost = [ (6% - 5% X $100,000) X 3 years ] PV’d at 5%.

i.e. ( 1% X $100,000 = $1,000 ) X 3 PV’d at 5%
$1,000 PV’d at 5% for 3 years = $2,723.25

*PV’d = the present value of $1,000 per year for 3 years at an interest rate of 5%

Payout = $100,000 + $2,723.25 = $102,723.25
Plus Penalty Interest = $100,000 X 6% X 3 = $6,000 X 3 = $1,500
( normally 3 months ) 12 12

Total Payout = $100,000 + $2,723.25 + $1,500 = $104,223.25

Example 2: Where interest rates have increased above the original fixed rate:

Balance owing = $100,000.
Remaining Term = 3 years.
Original Fixed Rate = 6%
Current Interest Rate = 7%

Cost = [ (6% - 7% X $100,000) X 3 years ] PV’d at 7%.

i.e. ( -1% X $100,000 = -$1,000 ) X 3 PV’d at 7%
-$1,000 PV’d at 7% for 3 years = - $2,624.32

PV’d = the present value of -$1,000 per year for 3 years at an interest rate of 7%

Payout = $100,000 - $2,624.32 = $97,375.68
Plus Penalty Interest = $100,000 X 6% X 3 = $6,000 X 3 = $1,500
( normally 3 months ) 12 12

Total Payout = $100,000 - $2,624.32 + $1,500 = $98,875.68

Author Name
Kevin Nowland -

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