The advance payment (prepayment) of a loan consists of reimbursing all or part of a financing before the agreed period.
The objective of this operation is to repay, partially or fully, the principal of a loan received. In this way, the term of indebtedness or the amount of outstanding payments can be reduced.
The prepayment of the loan is an attribution of the debtor, which may be subject to various conditions depending on the country’s legislation. In addition, the requirements vary depending on the type of financing.
Characteristics of the advance payment of a loan
Among the characteristics of the advance payment of a loan, the following stand out:
- By amortizing part of the principal, less interest payable is generated in turn, reducing financial expenses.
- It is not the same as the installment advance, which consists of paying the monthly payments for the next periods, for example, for the following two months. In this case, the debtor only seeks to stop making disbursements for sixty days. Financial expenses are not reduced.
- It is an operation to which the borrower resorts when he receives, for example, an extra income or when his remuneration increases.
Examples of debt prepayment
Let’s look at a couple of examples of how debt prepayment works. On the one hand, in Peru this operation is valid for all types of financing. The borrower can decrease the period of the credit or the amount of the outstanding payments.
For example, suppose a person took out a two-year consumer loan. After six months, the individual receives an extraordinary income and decides to amortize 20% of the principal.
Then you can reduce the term of the outstanding debt, for example, from 18 to 12 months. Another option is to lower the amount of the monthly payment, but keeping the financing time.
On the other hand, there are less flexible laws like the Chilean one. In that country, for example, among other rules, the payment of a prepayment commission is required. In addition, if we refer to a consumer loan, only when it is less than 5,000 Development Units (UF) is the advance payment a right that the creditor cannot oppose. Otherwise, your consent is required.
It should be explained that the UF is a unit of account used in Chile, readjusted according to inflation.