Should I reduce the loan term or the monthly installment?

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If you decide to repay part of the bank loan in advance, you will be faced with a choice: with this amount Term of the loan Reduce if Amount to be paid every month.

Although in both cases the amount deposited in advance covers the principal of the loan, there is still a difference between the two offers. To the question of which option is better to choose, the short answer is as follows: if you are not currently facing the problem of stable payment of the current monthly installment, it is better to shorten the term of the loan, although the choice still depends on individual factors, therefore, we recommend that you read the article to the end.

In order to find out which method has which advantage, so that you can make a decision based on your needs, Netgazeti spoke to banking analyst Davit Klidiashvili.

Before we start discussing this issue, let’s explain what a prepayment loan is. Paying part of the loan in advance means that we do not wait for the end of the 10- or 15-year schedule drawn up with the bank, and we try to reduce the principal amount of our loan in advance, which allows us to significantly reduce the size of the loan in the end and save money.

In general, the mentioned issue is regulated by the order of the President of the National Bank. In particular, according to the document, if at least 20% of the principal amount of the loan, which is at least 500 GEL, is covered in advance, the bank is obliged to offer at least two alternatives, and in case of depositing a smaller amount, it can do it within the limits of its own will.

One of the above-mentioned two methods involves shortening the loan term, and the other one, the monthly installment.

Before we move on to the discussion of each of them, it should be said that the longer the loan, the more interest the customer will have to pay in the end. Davit Kldiashvili notes that here we are talking about the total volume of the loan, not the interest rate.

For example, if a person has a 10-year loan and a 5-year loan at the same interest rate, the interest payable on the 10-year schedule will be higher than on the 5-year schedule.

Therefore, when we pay off a certain part of the loan in advance, if we have the opportunity to continue paying the same amount in the form of monthly installments stably, which we have been paying before and we want to reduce the total amount of the loan, in such a case, reducing the term is a more favorable solution.

In this case, your monthly contribution will remain unchanged, and if you have a 10-year loan, within which you pay 500 GEL every month, you will have to pay 500 GEL again the next month, however, depending on the amount of money paid in advance, the loan term will be shortened, conditionally – up to 8 years. Therefore, if you continue to pay the loan according to the schedule, you will finish it in 8 years.

According to Kldiashvili, shortening the term of the loan is more profitable if you start the repayment in advance of the loan at the early stage of the loan. As a rule, during the first years, most of the monthly contributions are used to pay the bank’s interest, and less is used for the principal.

Nevertheless, the analyst notes that, according to his observations, most people prefer to reduce the monthly payment when paying off the loan in advance.

To explain with an example, when reducing the monthly contribution, if the user pays 500 GEL per month for a 10-year loan conditionally, after depositing the amount in advance, the loan term will remain for 10 years, and depending on the amount of money, the amount of the monthly contribution will decrease and conditionally, the monthly payment will be reduced to 400 GEL.

According to Kldiashvili, this method is beneficial in the case when, for example, a person’s salary has been reduced or for some other reason he is no longer able to pay the same amount of money every month.

It is also important at what stage the advance loan is repaid. According to the analyst, if a person had a 10-year loan and has only 1 year left before the full repayment of the loan, at this time there may not be much difference between these two options.

To summarize, in order to correctly choose the method that is convenient for you to repay the loan, you need to define your own priorities. If paying the current amount of the monthly installment is not a problem for you and you start repaying the loan at an early stage, it is better to shorten the term. And in case, if alleviating the monthly pressure is a higher priority for you, you can cover part of the loan by reducing the monthly payment.



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