What is loan repayment and why is it important?

11 AUGUST 2023

After loan approval, you need to understand the most important part of having a loan, loan repayment. Learn more about what it is, how it’s calculated and why it is important in this article.What is loan repayment and why is it important

What is a loan repayment and how does it work?

Loan repayment means paying back the money you have borrowed from a lender. This is done through stipulated monthly payments over a certain period of time that cover your principal amount, which is the original sum of what you have borrowed, as well as interest charged on that amount for borrowing it. You can also pay your loan off in a lump sum before your loan term is over, however you might need to pay an early repayment fee depending on your contract.

If you’re unable to meet loan repayment, your loan becomes defaulted and negatively impacts your financial position and credit score as you incur a bad debt. Before this happens there are options you should explore; getting additional income, refinancing, speaking to a financial advisor or your lender to renegotiate the loan agreement.

Why Is loan repayment important?

Paying back your loan on time is very important as it can affect your loan liability and your credit history. Your debt repayment history shows other banks and lenders that you have either paid on time or not. Missing monthly payments have a negative impact on your credit health as it shows you have not kept up with payments in the past and therefore could be a higher risk. This then affects your future chances of applying for a loan, and how much interest you might be charged. This is why paying on time will help build a positive credit history, increasing your chances of being approved for a loan with lower interest rates.

How to calculate loan payments

Knowing how much you could be paying in loan repayments can help you manage your payment schedule and budget. Before you take on a loan, understand what type of loan you will receive as this will affect how your repayments will work.

Interest-only loans are when you pay the interest off in the first few years before paying anything off on the principal amount. Although your payments might be lower, you will eventually pay off the full loan amount in higher monthly payments or a lump sum. These types of loans are usually mortgages or used by people who have more cash flexibility.

An amortized loan is the more common type of loan as it includes both the interest and principal amount in your monthly repayments over a set period. Payments have to be made on schedule and are most often auto loans, personal loans, and student loans.

To calculate your loan repayments on an interest-only loan, use this formula:

Loan Payment = Loan Balance x (annual interest rate/12)

To calculate loan repayments on an amortized loan, use this formula:

  • A = Payment amount per period
  • P = Initial principal (loan amount)
  • r = Interest rate per period
  • n = Total number of payments or periods

A = P {r(1+r)n} / {(1+r)n –1}

There are many online calculators available to make this process simpler and to help you plan ahead.

How to manage loan repayments efficiently

The way you tackle your loan repayments is crucial as it can impact your future loan or credit relationships. Always pay on time to avoid a negative effect and you’ll set yourself up for success.