When people come into a bit of money, often their first instinct is to pay off old debts. But clearing a personal loan early can cost you. So, here’s some advice to help you avoid the pitfalls and ensure you end up better off.

Paying off a debt before the term is up is a great way to increase your monthly income. But it’s not always the most straightforward process. If you have a credit card, for example, you can clear it without any repercussion. However, paying off a personal loan ahead of schedule can see you hit with a penalty.

While some banks do not charge early settlement fees on personal loans, others charge one percent – the maximum penalty allowed under UAE Central Bank guidelines.

That means if you have an outstanding balance of AED 100,000, you will pay AED 1,000 to pay off the loan early.

The same applies to car loans. Clear the balance early and you will invariably be stung with a one percent early settlement fee.

The other thing to consider for personal loans is that if you took your loan out some time ago, the market may have changed and rates may have dropped. So, if you don’t have the money to pay off the balance now, it might be worth shopping around for a new personal loan and finding a deal that will reduce your payments.

However, you need to tread carefully. For a start, you may incur that one percent early settlement fee. Then you may be hit with upfront or arrangement fees on a new loan – which are also typically one percent of the loan.

Also, when sizing up a new loan, you must consider whether it is a flat or reducing rate as comparing the two will be misleading.

So, before you plough ahead with a new finance deal, do your sums to work out if switching to a new loan provider will actually leave you better off or not –

  1. The first step is to speak to the bank and find out what interest rate you are currently paying, how much you will repay if you stay with this deal and how much you will pay if you clear the debt now.
  2. Step two is to ask what the penalties are if you pay it off now.
  3. For step three, add together the cost of repaying the loan now to the penalty total and use this figure – let’s call it ‘figure A’ – to compare your loan with other personal finance options on the market.

Again, when considering those options, factor in the cost of any upfront fees with the total cost of a new loan and use a personal loan calculator to help you get the sums right.

Finally, if those other options can’t beat figure A, then stay where you are. However if the total cost of the new loan is less than figure A, go ahead with a new deal. It will free up more of your salary to cover everyday expenses; just make sure you don’t run up any more debt.