Interest rate bands
Posted 14 June 2012 - 06:49
I intend to take a loan and I intend to make overpayments very quickly. Are we right in thinking that although the amount we pay back per month will decrease the level of interest will not drop down. Eg. we borrow 5k at at rate of 5%, after a month we get it down to 3k. The associated interest rate will drop to 3% or will it remain at 5%.
Posted 14 June 2012 - 08:07
The interest rate remains the same throughout the life of the loan, but since it is charged on the daily outstanding capital balance, the actual cash amount of interest will fall as capital is repaid.
Whether your monthly repayments decrease, or the payments remain the same but the term of the loan is effectively reduced, depends on what arrangement you agree with Zopa when you make any overpayments.
Posted 14 June 2012 - 11:47
I am unclear whether you are refering to actual "interest rate", absolute interest payable or APR. As PoohBah says, the (constant) interest rate will be charged on the daily outstanding balance to give a lower amount of interest due after a repayment (there may be a slight anomaly in the first month if the early repayment is less than the accrued interest to that point, but it corrects at the next monthly repayment).
However, what Poohbah didn't talk about was the APR implications. The APR is essentially the interest rate plus the impact of the upfront costs (arrangement fee) when spread over the project. These costs are sometimes dependent on the size of the loan and vary depending on your credit category, but they are absolute amounts rather than percentages of the amount borrowed. So the actual cost will stay the same (or even decline) with an increasing loan size, but spread over the repayments will have a lower impact on the APR on larger loans.
Therefore, if you repay early, you will still have to meet these fees and so the cost will not go down and become a greater proportion of the overall cost of the loan (as the interest will have fallen). So in the extreme of repaying in full on the day it is disbursed, the cost would just be these fees (as inteerst would be nil).
As for the interest rate, this will rise slightly as the loan size increases as it may need to draw funds from higher rate loan offers.
Edited by propman, 14 June 2012 - 11:49.
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