In exchange for a commitment to repay the principal amount with interest, you receive a loan from a bank or financial institution. After getting a loan from a bank or another institution, the borrower is required to repay the debt; this is known as loan repayment.
Lenders take the risk of a possible default and charge interest to offset this risk.
A secured loan requires collateral, so if you default or don’t pay back the loan, the lender can take possession of the asset you pledged as collateral.
There is no collateral required for an unsecured loan. If you don’t repay the loan, the lender will not be able to take anything from you.
The most common types of loans are home loans, car loans, personal loans, education loans, business loans, personal lines of credit, and debt consolidation loans.
How Does Loan Repayment Work?
Repaying a loan typically includes both principal and interest payments. The principal refers to the original sum of money borrowed in a loan, while interest is the charge for the privilege of borrowing money. Loans can usually also be fully paid in a lump sum at any time, though some contracts may include an early repayment fee.
Many people have to repay auto loans, mortgages, education loans, and credit card debts. Additionally, businesses may enter into debt agreements, such as auto loans, mortgages, and lines of credit, as well as bond issuances and other structured corporate debt. When you fail to pay off your debt, you may be forced to file for bankruptcy, charged more for late payments, and your credit rating may change negatively.
What is the process of loan repayment?
When consumers take out loans, the lender expects that they will ultimately be able to repay them. Typically, interest is expressed as an annual percentage rate (APR) for a period of time between when a loan is granted and when the borrower returns it in full. It is calculated on a contract rate and schedule.
Borrowers who are unable to repay loans may seek bankruptcy protection. Borrowers should examine all their options before declaring bankruptcy. (Bankruptcy can affect a borrower’s ability to obtain financing in the future.) Other options for bankruptcy include earning additional income, refinancing, obtaining support through assistance programs, and negotiating with creditors.
It is best to be proactive and reach out to the lender to explain any existing circumstances. If there are any setbacks such as health events or employment problems which may affect the ability to pay, some lenders may offer special terms for hardships.
Here’s an example to illustrate.
The loan term is 10 years and you have a 10% interest rate on the loan.
Below, you can see how the interest and principal components will be divided over the loan’s term.
Loan Repayment: What Is It?
On a loan of 20 lakhs, the breakdown is as follows:
Amount of EMI: $26,430
There is a total of 11,71,618 in interest payable
Payment total (principal + interest): 31,71,618
As you can see from the screenshot below, the interest amount gradually decreases and the principal repaid gradually increases with each passing year, leading up to the end of the loan.
The Loan Repayment Process – Part 2
The amortization table can be obtained from your bank or can be calculated using a loan repayment calculator.
MoneyTap’s loan repayment calculator generates the amortization table above. If you are wondering how loan repayment works in MoneyTap, click here.
What Is the Importance of Loan Repayment?
As well as reducing your loan liability and interest accrued, loan repayments reflect on your credit score as well. A missed installment payment could result in higher interest charges (for missed installment payments) or a bankruptcy declaration (for non-repayment). In the long term, your credit health will also be affected, which will be reflected in your credit score.
What Is the Impact of Loan Repayment on Your Credit?
Your credit health determines how you will perform as a user of credit. Factors contributing to your credit health, including your credit utilization ratio and your repayment history. A positive repayment history is indicated if you have always made your repayments on time and never missed a single installment. Some borrowers are unaware that their credit history with one bank is visible to all other banks through their credit reports. Credit bureaus compile such data from various sources and make it available in the form of a credit report and credit score to banks on request.
Unfavorable repayment history makes you a risky customer for banks. They can deny your loan application or charge you higher interest rates based on the perceived risk of recovering the loan amount.
What are the benefits of loan repayment for your credit score?
Your credit health can be adversely affected by irregular repayments. On the other hand, timely repayments help you build a good credit history and improve an existing credit score.
If you wish to build a good credit history from scratch or want to improve your credit score, make all your future loan repayments on time regularly.
Repayment Types
Student loans from the federal government
In some cases, federal student loans can be forgiven, with lower payment amounts, and postponed payments. Especially useful if a recipient is experiencing a financial or health crisis, these types of loans provide repayment flexibility as well as the ability to refinance their student loans as their lives change.
In order to repay the loan plus interest, regular payments are the best option. With regular payments, the debt is satisfied in the shortest amount of time possible. This method also accrues the least amount of interest. For most federal student loans, repayment is required for a period of 10 years.
There are also options for extended and graduated payment plans, both of which require you to repay the loan over a longer period of time. It is unfortunate that extended repayment periods come with additional interest charges that will eventually have to be repaid.
Unlike standard repayment plans, extended repayment plans allow borrowers to repay their loans over a period of up to 25 years. Because they have longer to pay back the money, their monthly payments are lower. However, the bothersome interest fees compound their debt as they take longer to repay the money.
Graduated payment plans, just like a graduated-payment mortgage, have payments that increase from a low initial rate to a higher rate over time. In the case of student loans, this is meant to reflect the idea that long term, borrowers are expected to move into higher-paying jobs. This method can be a real benefit to those who have little money straight out of college, as income-driven plans may start at $0 per month. However, once again, the borrower ends up paying more in the long term because more interest accrues over time. The longer the payments are drawn out, the more interest is added to the loan (the total loan value increases as well).
Students may also research their eligibility for student loan forgiveness if they teach in a low-income area or work for a nonprofit organization.
Home Mortgages
If a homeowner is delinquent on their mortgage repayments, they have a variety of options to avoid foreclosure.
A borrower with an adjustable-rate mortgage (ARM) may attempt to refinance to a fixed-rate mortgage with a lower interest rate. A borrower can pay the loan servicer the past-due amount and late fees and penalties by a set date for reinstatement if the problem with payments is temporary.
In forbearance, payments are reduced or suspended for a set period of time. Regular payments are then resumed along with a lump sum payment or additional partial payments until the loan is paid off.
Loan modifications involve altering the terms of a mortgage contract so they are more manageable. In addition to changing the interest rate, extending the loan term, or adding missed payments to the loan balance, modification may also reduce the amount owed by forgiving part of the loan.
Selling a home may be the best way to pay off a mortgage, and may prevent bankruptcy.
Repayment methods for loans
Here are some loan repayment options; however, your lender and loan type may determine which loan repayment option is available to you:
1. EMIs:
Every monthly installment, referred to as an Equated Monthly Installment or EMI, involves a portion of the principal and a portion of the interest and is scheduled to be paid over a fixed period of time.
However, some banks offer their borrowers the option to prepay their loans after a certain number of installments have been made. Some banks may charge a fee if you prepay your loan.
If you pay off your loan in part, it reduces the principal, saving you money on interest, since interest is applied to the reduced principal.
When you pay off your loan in full before it is due, this is called full pre-payment or pre-closure.
2. Bullet Repayment:
There are some loan products that allow you to repay the loan through bullet repayments. When the loan tenure ends, you need to make one bullet repayment that pays off the entire principal.