Loan Interests and Penalties: Understanding Your Debt Payments

Despite basic knowledge on interest payments on loans and debts, many individuals still wail over the so-called “evils” of interest payments whenever a billing statement for a loan takeout arrives and they see the outstanding balance and periodic payment required.

How can one lessen interest rate payments on badly needed loans? Are there ways to gain the upper hand when it comes to making interests and payment add-ons more flexible and personalized? Read on.

When we take out a loan from standard creditors like banks and lending agencies, we understand that we pay not only the principal or original amount of money that we owed but also a certain amount called interest. Interest payment is the profit that lenders and creditors earn from the business of lending, and which the borrower agrees to pay.

As a concept of profit, it can be simply said that the interest is the value of the money lent should the owner or the source decided to use it in an income-generating activity, like depositing it in a bank or investing it in a business, instead of lending it to the borrower.

The subject of interest can be peanuts to some math wizards, but for the average consumer, it is matter of losing substantial amount of money when it is misunderstood as a fixed, annual or simple percentage of a loan or debt. Hence, our aim is to revisit the concept of interest as an accompanying condition in loans and to show the different ways to lessen interest payments through personal initiative and “tactics”.

Interest payment: the deeper meaning

While understanding interest especially as applied to loans and debts needs no extraordinary intelligence, understanding how it works requires willingness and a level of dedication on the part of the average consumers to fully understand it, and thereby make good and informed decisions when taking out loans and paying for them.

Disclosure or full transparency on the equivalent yearly compounded interest rate on loans or debts is standard international practice among financial institutions. This mandatory requirement helps consumers (borrowers) in knowing the full amount of the payment they have to make, and to compare “price” of one loan option with another. As such, understanding the workings of interest is an utmost important skill.

Terms of “interests” to watch out for

1.  Compound (or compounded) Interest Payment

A compound (or compounded) interest is an interest one pays for the principal plus the amount of interest from past periods (months or years). Some described it as “earning interest over your interest.”

Credit card is the host financial instrument for the evils of compounded interest – that is if one does not pay the latest purchase in full, calmed by the fact that there is a minimum payment due on their billing statement.

While it is elementary knowledge that paying only the minimum amount due is the best way to grow and groom your compounded interest payment, some credit card owners also take refuge in the figures stated in their total credit or purchases. They fail to include the compounded interest that will accrue if they do not make an effort to pay as much as they can to cover the purchases on credit, and never just the minimum amount or a slightly higher amount than this.

2. Interest Payment Accumulation

Knowing how compound interest works is important especially since most loan and debt instruments apply this type of interest as standard practice.

On the borrower side, this knowledge makes one fully aware of how much money one actually has to pay, either as a percentage of the principal or as a portion of say, your savings account.

For eaxmple, when a loan is taken out, a payment portion of the principal plus an agreed interest rate is billed on the first payment schedule. For the next payment, interest is calculated and to be paid based on the original principal plus the previously earned interest. The same process applies to the next payment, and so on.

Simply put, compound interest makes more money  in profits (earns more) for the lenders or creditors; and hence, more payment for the borrower.

Avoiding The Perils of Compound Interest

Photo 2Understanding that credit card networks, card companies and their merchants as well as government regulators agree to compound interest as international practice, one can never escape from its “evils” except through responsible credit card ownership and payment fulfilments.

However, this does not mean that just because it is the practice, one must contend with it. Not at all. The good news is there are ways to outsmart the compound interest foe, and free one’s self from higher debt payment woes.

1. Seek out alternatives from compounded interests

Try a simple interest loan, which requires an interest amount for a total or whole loan or borrowed amount that is not compounded or does not grow or increase over time. It can also mean that only the principal amount generates interest.

Although simple interest rate loans offer lower payments than compounded interest loans, it doesn’t mean that the borrower will enjoy the lowest payment terms. Late payments on simple interest loans will also accrue. Here is a good explanation on how mismanaged simple interest debts can also backfire.

There is also the fixed Interest loan, an arrangement where the interest rate doesn’t fluctuate during the fixed rate period of the loan. The fixed rate can be applied to the entire duration of the loan payment or within a certain period only.

Fixed interest rates are usually negotiated in home loans, and its utmost benefit enjoyed during low interest periods. This is the contrast of the variable rate loan, where interest payments varies over time depending on market conditions.

Although simple and fixed interest rate loans are alternatives to compounded interest rate loans, they still incur payments that will balloon to unmanageable if the borrower becomes delinquent.

2. Propose for a personalized and flexible interest rates payment

Some lending companies offer personalized payment terms for a loan based on several factors, like the borrower’s financial situation, sources of income, personal and business assets, and even endorsements that serve as guarantees of trust from credible references.

Repeat clients who have demonstrated their responsibility and capacity to pay for loans taken out with the same lender, or even from a different lending institution are also considered for these special payment arrangements.

If you want to avail of personalized terms, ask someone who have prior experience in taking out these loans. When negotiating, make sure there are no hidden or vague terms like incremental interest rates on a daily basis if one is late in paying, which amounts to a compounded interest rate just the same, or even higher. Also, consult a free legal assistance group about the special terms given to you.

3. Explore funding assistance from livelihood programs

Rather than conventional bank loans and debt takeouts from lending agencies, why not opt for public or nonprofit capital fund assistance programs? This is especially helpful for those who intend to use the loans for a personal business or a livelihood support venture.

The government has various credit lines for these purposes, and they have much lower interest rates and flexible payment terms compared to banks and corporate lenders. Check out some of these programs’ offices (your community centers should have references for them) and arrange a meeting to see if you qualify.

4. Mix no-interest loans from friends with standard interest rate loans

This is a practical way to save on loan interest payments especially if you need a high amount of money. By rounding up your needed amount from a mix of no-interest, low-interest and standard (compounded) interest loans, you lessen the amount of the principal from which the standard interest rate will be based.

Lower principal means lower interest rates. Just make sure that for all your debts, whether it is a no-interest family loan or a bank loan, you exercise diligence and promptness in payment.

5. Make your own “offers” to the lender

Some money-lending agencies and even banks want to build a good base of responsible borrowers. Try to make some personal offers in exchange for prompt or advance payments, repeat businesses or promising referral lists.

Some ways to further cut back on interest payments of any sort with this arrangement include negotiating for repayment holidays (especially for high-spending seasons like school openings and yuletide) and waiving of processing or administrative fees for the loans.

Do you have fresh ideas on how to win over high interest payments for loans and debts?


James Anthony

By James Anthony

A senior FinancesOnline writer on SaaS and B2B topics, James Anthony passion is keeping abreast of the industry’s cutting-edge practices (other than writing personal blog posts on why Firefly needs to be renewed). He has written extensively on these two subjects, being a firm believer in SaaS to PaaS migration and how this inevitable transition would impact economies of scale. With reviews and analyses spanning a breadth of topics from software to learning models, James is one of FinancesOnline’s most creative resources on and off the office.

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