Beat the loan penalty trap

Loan firms are cutting back on penalty fees for borrowers who pay off their debts early, new research from MoneyExpert.com reveals. More than one in five loan firms now don’t charge early redemption fees.

And they include some of the firms offering the best rates on the market such as Northern Rock with 5.9 per cent and Zopa’s A-Star Personal Loan at 4.9 per cent on loans of £5,000.

However most firms still charge at least one month’s interest to customers who clear their balances ahead of the term agreed at the start of the loan – and two companies charge as much as two months interest.

MoneyExpert.com is urging borrowers to research the market thoroughly before taking out a personal loan as the cost of paying the loan off early can be as much as £255.70 on a £5,000 loan borrowed over four years.

Sean Gardner, Chief Executive of MoneyExpert.com, said: “Early redemption charges can be misleading – for example if you have to pay two months’ interest to pay off a three year loan early, this is an effective increase in the headline rate of one sixteenth. So a competitive rate of 5.9 would theoretically become 6.26.

“But paying off a loan early makes sense as it cuts down your interest bill and helps you become debt-free.

“But it can come at a price and while early redemption penalties can be a price worth paying it is better to avoid them entirely by taking out a loan which doesn’t charge fees. If you believe you will pay the loan off before the end of the term then research the market before you buy.

“Redemption penalties are not the only factor to focus on when borrowing but they can be painful if you do pay the loan back quickly. And it is now relatively straightforward to find a company which does not charge redemption penalties.”

Companies justify charging early redemption penalties on the basis that they have lent the cash on a fixed term and guaranteed a fixed interest rate for the period. They therefore charge a penalty for early redemption to compensate for their risk.

The Consumer Credit Act of 2004 restricted loan companies to charging a maximum two months interest for early redemption but most companies have cut that to one month. And around one in five of the 90 loans on the market from around 64 companies charge no penalties.