Smarter loan management
Ensure you have the best terms
5 minutes
Signing a loan agreement or lease contract does not mean you're stuck to those terms forever
Before diving down, please be aware of the difference between Principal and Interest.
The principal refers to the amount borrowed, and the interest is charged on this amount. The primary thing to keep in mind is that only repayment of the principal will reduce the total amount borrowed.
Here are a few ideas that could help:
1. Target for a larger down payment
The down payment is referred to the initial money that you need to pay or put forward before borrowing the money.
The table below illustrates two scenarios where placing a larger amount was more beneficial. Let’s say that you are planning to purchase a motorbike costing MVR 70,000 over 3 years with 3% interest.
The basic rule is that the larger the down payment, the lower your monthly repayment and ultimately how low the final cost will be.
For the example above, deciding to make a larger down payment meant that the monthly repayment was lowered by MVR 436.
Keep in mind that when the down payment is higher, the borrowed amount will be lower. This would mean that the interest paid would also reduce resulting in a lower total cost.
For the example above, you would have saved around MVR 700.
It may not seem much, but for bigger loans, an optimal down payment can save you thousands.
Alternatively, if you don’t have the ability to conjure up a large down payment figure, that is fine as long as you’re able to understand the impact it will have on you.
2. Early repayment
Some borrowing terms will allow you to make an early repayment on the Principal i.e. the total amount originally borrowed.
Similar to how the down payment impacts the monthly payment amount and other elements, by depositing towards an early settlement can be beneficial.
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That said, if you receive a large once-off inflow of money, for example via annual bonus from work, consider placing a portion of it to reduce the overall debt obligations and save on future interest payable. This would also reduce the time taken to repay the loan.
Pro Tip!
Be careful as some institutions may charge you a fee for early repayment such as 1% of the depositing amount.
3. Increase payment frequency
Usually, repayment of loans is structured to be paid on a monthly basis. If your income allows, consider entering into an agreement where you can repay every two weeks.
Similar to the point above, repaying more frequently would reduce the loan amount more quickly and you would save on the total interest paid.
4. Increase loan duration
In contrast to the earlier point, you may also consider requesting your loan to be repaid over a longer duration. Banks refer to this as a ‘restructure’ of your facility.
This is useful during situations where you wish to reduce the amount paid monthly.
The table below illustrates how the same long-term loan changes when the duration is altered. Let’s assume that you have taken out a loan for MVR 1m at 12% interest for five years. After two years, you wanted to request the loan to be extended into six years:
As shown, once the loan duration is increased on the balance amount, the monthly commitment is reduced significantly.
However, note that this would mean that the total interest paid by the end of the loan would be much higher. Use this only if you want to reduce the monthly payment amount.
5. Switch to a different lender
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Wait, you can do that? Yes.
If you see that another financial institution is able to offer you a lower interest rate, you can consider moving that loan. Banks refer to this as ‘refinancing’.
Say for example, that your current rate of interest is 18% and you find that there is another lender ready to arrange that same loan for 12%. This would have a combination of benefits mentioned in point number four and you would enjoy a lower total interest payable.
However, be careful of the following:
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The existing lender may charge you a fee for this
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If your existing loan has a mortgage, for example a house, the legal process may take some time to switch lenders – an additional fee may also be involved.
6. Be wary of grace periods / moratorium
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A moratorium refers to an arrangement where the lender allows you to delay the repayment of your loan – it’s also referred to as a payment holiday.
Unfortunately, that destination isn’t always sunshine and rainbows.
Lending institutions may allow this grace period on both the principal and interest but you’re still expected to pay them back of course! In the case where the moratorium is granted on principal only, they may even request you to repay all the interest during that ‘holiday period’ in one-go.
Doesn’t sound too nice now, does it?
It has its benefits where if you have a big hit to your income, say you lost your job for example, then arranging a grace period on your loan will give you some breathing space and allow you to repay only when it is possible for you.
In practice, some real estate developers may begin the loan with a one-year grace period such that as the building gets completed, the rental income from the floors will service, i.e. pay, the loan.
Pro Tip!
Some banks may charge 'interest on interest'. This means that interest will continue to accumulate during the grace period even if you're continuing to repay the scheduled interest portion of the loan. Speak to your Banker to check if this is included and request for a before and after comparison following the changes to your loan.
7. Understand the fees involved
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There are several costs of borrowing money and some of them are not apparent at first glance.
These could include:
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Front-End Fees – this is a fee taken on the loan amount generally a set percentage on the total borrowing
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Legal Fees – particularly in the case where you need to mortgage an asset, this may be also be charged
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Stamp Fees – not to the cub scouts but towards the registration at relevant courts and ministries where applicable
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Early Repayment Fees – charged for repaying earlier than the plan provided by the lender
Before signing any agreement, you should clarify all potential (or hidden) costs involved.
8. Use the collateral to your advantage
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The general rule for lending against a collateral is that the value of the security must be around 150% to the amount that you're borrowing. For example, if you're borrowing MVR 100, then the collateral that you're mortgaging should be valued at MVR 150.
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If your collateral has good value and you need the additional funds (provided you can support the extra repayment), don't hesitate to negotiate with your Banker to increase the loan amount.
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In the current market, the most ideal collateral from the Bank's perspective is a land/building. This is because, generally, the value of land keeps on increasing. Banks have now moved away from high risk collaterals such as vessels.
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Some banks may also determine the interest rate based on the 'risk' that the collateral represents. For example, if you have a Fixed Deposit, the Bank may be ready to offer you a much lower interest as it is essentially lending against 100% cash.
Want to plan your loan arrangement?
Use our Loan Calculator tool to experiment with repayment options and cost: