Whether you borrow money to purchase a house, car, or any other big expenditure, the debt is to be paid down in fixed monthly instalments. The repayment term plays a crucial role in deciding the cost of the debt. Most people choose a longer repayment plan, believing that it is more affordable, but the fact is that it costs you a lot more money. In order to explain it, the following table has been drawn.
| Repayment term (1 year) | Repayment term (2 years) | |
| Loan amount | 10,000 | 10,000 |
| Interest rates | 25% | 25% |
| Fees | N/A | N/A |
| Monthly instalment | £938.46 | £521.37 |
| Interest payment | £1,261.56 | £2,512.84 |
| Total loan amount | £11,261.56 | £12,512.84 |
As you can see, when you extend the repayment term, the size of the monthly instalments is significantly reduced. Undoubtedly, this will be more affordable for you to pay down around £500 instead of £900 every month, but you end up paying more than twice as much in interest overall. The longer the repayment period, the higher the total interest will be.
Repayments of student loans
When you take out a federal student loan, you believe that you do not have to pay down interest, but that is not true. Federal student loans work differently from those of direct lenders. You are obligated to start making payments after you start earning money, and yet you must be able to earn more than the threshold income to start making repayments.
The threshold income is £21,000 per year, £404 per week, and £1,750 per month. You will be obligated to pay down an instalment towards student loans only when you are earning more than the threshold income.
Your employer will cut repayment directly from your salary, along with tax, and the student loan repayment will be shown on your pay slip. At the end of the year, your employer will inform HMRC of the total money they have repaid, and then HMRC shares those details with the Student Loan Company so that it applies repayments to your balance.
Payments stop when your earning falls below the threshold limit, and they automatically start when you are back to earning more than the bare minimum. If you are self-employed, the HMRC will decide how much money you owe when you file your tax return.
How repayments are made
You will be required to pay 9% of your income over the threshold limit. For instance, if you earn £2,000 every month before taxes, you will have to repay 9% of the income over the threshold limit.
£2,000 – £1,750 = £250
9% of £250 = £22.5
So, your student loan repayment will be £22.5 every month unless your income goes up. The repayment amount will automatically change when your income increases or falls.
They are not immune to interest
You are living under the impression if you think you do not have to pay interest on student loans. Interest is charged from the day you start making repayments until the whole debt is settled. The amount of interest is charged based on the rate of inflation. Using the RPI (Retail Price Index), interest rates are revised once a year in the month of September.
Mortgage repayments
The repayment term of a mortgage varies by lender. If you are looking to get your foot onto the property ladder, in the first two years, you will likely be on a fixed interest rate deal. Once this period expires, you will be automatically put on standard variable interest rates.
The repayment term you will be offered depends on your overall repayment capacity and how much debt you owe. For instance, if you choose to deposit a larger down payment, it reduces the mortgage amount. Of course, you will be able to qualify for lower interest rates.
Since the size of monthly instalments will not go up, you can easily settle your mortgage within a short period of time. Unfortunately, that scenario is not available with bad credit mortgages.
| Interest-only mortgages | Repayment mortgages | |
| How much will you pay each month? | Only interest will be paid down. | Along with interest, some part of the payment will go towards the principal. |
| How much will you owe at the end of the term? | The full amount of the mortgage principal. | Nothing, as you would have already settled the whole debt. |
| What will be the monthly interest? | Monthly interest will be charged on the full mortgage balance. | Monthly interest will be charged only on the outstanding balance that you owe |
| Associated risks | Inability to keep up with payments will result in repossession of your house. You might not have enough money to pay back at the end of the term. Your credit rating will also be affected. | If you fail to keep up with repayments, you will likely lose your house. Foreclosure shows up on your credit file, ruining all chances of getting affordable deals down the line. |
Repayments of personal loans
There are various types of personal loans. Some are high-cost short-term debt, while others are required to be paid down over an extended period of time. Small emergency loans come with a very short repayment term, which cannot exceed a month. In most cases, it is about 14 days only.
However, if you borrow a large amount of money, say, a 2,000 pound loan from a direct lender, the repayment term will be one year. You will be paying down the whole debt in fixed instalments. If the amount is larger, the repayment term could be up to five years.
- You will have no flexibility to choose a repayment term.
- Payday loans and other small emergency loans are paid off in one fell swoop.
- Small loans cannot help improve your credit score.
- Instalment loans can improve your credit rating if you settle the whole debt on time.
The bottom line
Repayment terms vary by loan. Some loans are discharged in full within a very short period of time, while others are paid off in fixed instalments. You should carefully consider the repayment length while choosing a loan.
