Conventionally, early repayment of your loans is considered a good thing. It is because paying your loans ahead of time allows you to:
1) Save on interest
2) Access more cash with every paycheque
3) Be eligible for a another loan because you have a lower debt-to-income ratio
4) Have less mental stress since your debts are already sorted.
However, it's not always the case. Most loans come tagged with several caveats especially on early settlement. We look into the case of student education loans removed for tuition fees and assess the explanations why you shouldn't pre-pay your university loans ahead of time.
#1 Opportunity Cost
It may not always seem sensible to pre-pay the entirety of the student loan. While you might be conserving the quantity of interest you need to pay for inside your monthly repayments, you will lose out on the interest to become earned whenever you leave your cash staying with you.
Most savings accounts in Singapore operate on a tiered interest basis. This means that you stand to earn more interest should you have a higher balance inside your account. If you study inside a local university like NTU, NUS or SMU, the price of your whole candidature ranges from a minimum of $28,000 or more, which means a similar amount of funds in your banking account to become generating higher-tiered interest.
#2 Early Settlement Penalties
Some loan contracts include early settlement penalties or exit fees. For instance, Maybank's education loan only allows changes to the agreed amount of the borrowed funds tenure if you pay a prepayment fee or an administrative fee.
Some interests are also pre-computed even if you're settling the loan in front of the agreed loan tenure. Lenders calculate the amount of interest you'll pay within the agreed loan tenure and combine it with the main amount due. This means that paying ahead may have no bearing on whether you save more income and you may even incur additional expenses which are unnecessary.
#3 The inability to Enhance Your Credit Score
Ironically, taking your time and effort to pay off financing would bring about building a healthy credit rating, because it accumulates a longer good reputation for timely and responsible loan repayment. When you quickly (or immediately) repay your loans , it's considered a closed account in your credit history. This shortened payment history decreases the diversity of your credit portfolio.
While you do eventually have to close a credit account, a way of reducing its negative effect on your credit rating would be to make sure that you have adequate payment history and existing open accounts.
#4 Cashflow Inflexibility
When you surrender a large amount of money to repay your principal, you're taking from your savings buffer. In early stages of your career, the possible lack of a savings buffer may mean greater stress for you personally at the office because you face cashflow inflexibility to create a job or career switch if you have the need to.
You may require the extra buffer of money based on your lifetime stage as well. Your expenses invariably increase if you are going to get married or buy a house, and a savings buffer might be the emergency fund that you will have to tide you thru this period of increased spending.
No One-Size Fits All
Of course, pre-paying the loan in full ahead of the loan tenure is not always the worst. When it comes to paying while using CPF Education Scheme the accrued interest will have to be paid entirely along with the principal amount. However, the interest accrued benefits the person who loaned the amount as that might be the interest generated if the principal amount happen to be left within their CPF.
Additionally, having the funds restored in their CPF permits the CPF member to make use of the monies for investing, purchasing a property, drawing out for his or her retirement or earning the risk-free interest from the CPF Board rather than of your stuff.