Repayment is the act of paying back a lender the money you’ve borrowed. Typically, it consists of periodic payments toward the principal—the original amount borrowed—and interest, a fee for the “privilege” of being lent the money. Some loans even allow you to repay the full amount at any time, though there might be early repayment fees.
Loan repayment is a common financial obligation, affecting everyone from those with low incomes to the wealthiest. Most people are dealing with one or more of the following: auto loans, mortgages, education loans, and credit card charges. Businesses, too, often manage a portfolio of debts that include mortgages, lines of credit, bonds, and other structuredcorporate debt.
Falling behind on repayments isn’t just a minor hiccup—it can trigger severe consequences like involuntary bankruptcy, late payment charges, and a damaging blow to your credit rating.
Key Takeaways
- Repayment is the process of settling a debt, typically through set payments over time toward the principal and interest.
- Repayment terms are detailed in the loan agreement, including the contracted interest rate.
- Federal student loans and mortgages are among the most common that individuals repay.
- If you're a borrower facing financial or health problems, you may have choices if you can't make regular payments to your lender.
How Repayment Works
When consumers take out loans, their lenders expect they will likely repay the debt.Interest is charged based on an agreed-upon rate and payment schedule from when a loan is disbursed to when it's settled. When making loans, financial institutions forgo other investment opportunities that could offer returns. The interest charges pay them for this opportunity cost and the risks associated with lending. Usually, interest rates are presented as an annual percentage rate.
Repayment schedules depend on the type of loan and the lender involved. Whether applying for or paying off a loan, it's crucial to study the sections of the loan agreement outlining your options should you be unable to make scheduled payments. Borrowers who can't cover their loans may turn to bankruptcy protection. However, it would be best to explore this as a last resort since it will significantly affect your ability to take out loans in the future.
Alternatives to this drastic step include refinancing the loan, seeking help from debt relief companies or credit counseling agencies, and directly negotiating with creditors. When the unexpected happens, and you must miss one or more payments, it's often best to contact your lender before missed payments and fees escalate. Some lenders may even offer special terms for those facing hardship.
Types of Repayment
From covering education expenses to buying a new home or car, achieving your financial goals often requires borrowing money. Each kind of loan has a specific purpose and has its own repayment terms. Auto loans, for example, usually have fixed interest rates and are designed to be paid back within a few years. Mortgages are long-term commitments that can last several decades and may have variable interest rates. Student loans may have deferment options, allowing borrowers to delay payments as they continue their education or are unemployed for an extended period.
When taking out a loan, you obtain money from a lender—typically a company, financial institution, or government entity. Your agreement with the lender will specify the expectations for repaying your debt. While the terms may vary, here's a look at the primary forms of repayment for the most common types of loans.
Federal Student Loans
Federal student loans typically permit reduced or deferred paymentsandloan forgiveness in some instances. Plans for widespread forgiveness of federal student loans remain the subject of intense political debate and legal challenges.
Whatever the long-term outcome of student debt forgiveness, these loans typically have some flexibility. Your options forstudent loan refinancing change as your life does. This can be particularly helpful if you're facing a health or financial crisis.
Standard payments are the best option: regular payments—at the same monthly amount—until the loan plus interest is paid off. Regular payments satisfy the debt in the least amount of time. Also, this method accrues the least amount of interest. For most federal student loans, this means a 10-year period of repayment.
Other choices include extended andgraduated payment plans. Both involve paying back the loan over a longer period than the standard option. Unfortunately, extended time frames go hand in hand with accruing additional interest charges during the deferral that will eventually need to be cleared.
Extended repayment plans are just like standard repayment plans, except the borrower has up to 25 years to pay back the money. Because this takes longer, the monthly bills are lower. However, the interest fees can significantly increase the tab for the initial loan since they cover the additional time until the loan is settled.
Graduated payment plans for student loans, like graduated payment mortgages, feature payments that start low and gradually increase over time. This is meant to accommodate borrowers who are expected to earn higher incomes later in life. Graduated payment plans can offer a real benefit for those with limited earnings straight out of college, as the initial payments can start as low as $0 per month. However, once again, the borrower ends up with higher long-term costs. Because payments are lower initially, additional interest accrues over time, increasing the overall loan balance.
Student loan borrowers can explore if they are eligible for loan forgiveness. Among those who may qualify for debt relief are teachers, service members, Peace Corps and AmeriCorps volunteers, first responders such as police officers and other emergency service workers, government and tribal employees, workers at certain nonprofit agencies, and those who have made 20 or more years of payments toward their loans.
Home Mortgages
Homeowners facing difficulties with their mortgages have some choices tostave offforeclosure.
Borrowers with anadjustable-rate mortgage may be able to refinance their loans as a fixed-rate mortgage with a lower interest rate. If the problem with payments is temporary, borrowers can work toward reinstatement, paying the lender the past-due amount, along with late fees and penalties, by an agreed-upon date.
Payments are reduced or suspended for a set time if a mortgage goes into forbearance. Regular payments then resume along with a lump-sum payment or additional partial payments for a specified period untilthe loan is cleared.
Loan modifications offer another potential means of relief. These are adjustments to the mortgage to make payments more manageable, including lowering the interest rate, extending the loan term, or rolling missed payments into the existing loan balance. Sometimes, a part of the mortgage may be forgiven, reducing the overall debt.
Under certain circ*mstances, the most feasible solution may be to sell the home and use the proceeds to pay off all or part of the mortgage. This strategy can help those behind on their payments to avoid bankruptcy. For some, selling the home may be the least-worst option. It can help those who have fallen behind on their payments to dodge the long-term consequences of bankruptcy. Once in default, depending on the jurisdiction and other factors, the house could be seized as an asset anyway.
Forbearance, Consolidation, and Debt Relief
Some debts may qualify for forbearance, a temporary relief that allows borrowers to pause or reduce payments because of financial hardship. While this option can give you time to recover financially, interest will continue to accrue during the forbearance period. Deferment choices also exist, particularly for federal student loans, for borrowers who are unemployed or whose income is too low to make payments. It's best to communicate with lenders once events have affected your ability to cover your loan payments—before your problems build further.
If you hold several federal student loans, credit cards, or other types of loans, consolidationmight be an option worth exploring. Consolidation combines separate debts into one loan, typically with a fixed interest rate and a single monthly payment. This could extend your repayment period and reduce the amount due for individual monthly payments. The downside is that you will likely end up paying more in interest over the life of the loan.
An alternative to consolidation isdebt relief, not to be confused with federal debt forgiveness proposals using the same name. Rather, it's when a company negotiates with your creditors on your behalf. Debt relief or debt settlement is generally offered by for-profit companies that charge a fee if they successfully get your creditors to reduce the total amount of your debt.
Alternatively, credit counseling agencies, usually nonprofit firms, can advise you on financial management and debt control while helping to restructure your debt payment schedule. These agencies work with your creditors to lower your interest rates or waive certain fees, including those for late payments and collections activities, so your monthly debt payments are more manageable. However, they typically can't reduce how much is left of the debt you owe.
What Is a Grace Period When Repaying Loans?
A grace period is a set time after the due date when a payment can be received without penalty. Not all loans offer grace periods, and terms can vary among lending institutions and the loan type. If a loan has a grace period, making a payment within this window can help you avoid late fees, although interest may still accrue. This is not to be confused with a loan moratorium, which is a more extended period, like deferment or forbearance, when your lender allows you to stop making payments while you get your financial house in order.
What Happens If I Don't Repay a Loan?
Failing to repay a loan can have serious consequences for your finances and credit. Initially, you may be hit with late fees and an increase in your loan's interest rate. If nonpayment continues, the lender might send your account to a collections agency, further damaging your credit score. Legal action may result, potentially leading to wage garnishment or asset seizure depending on the type of debt. All these actions can remain on your credit report for years, making it difficult to secure loans or credit in the future.
What Can I Do If I'm Having Trouble Repaying a Loan?
If you cannot afford your loan payments, you may have choices other than simply not paying. You can start by reaching out to your lender to explain why you're having difficulties. Many lenders offer forbearance or deferment choices for borrowers going through temporary financial hardship. You can also consider refinancing, consolidating your debts, or seeking support from a debt relief program or credit counseling agency. Declaring bankruptcy should generally be a last resort to resolve insurmountable debts, given it will have a significant, negative impact on your ability to borrow in the future.
What Are the Avalanche and Snowball Methods of Repayment?
Avalanche and snowball are names given to different strategies of paying down your debt. The “avalanche” approach calls for sending in the minimum payments on all debt and putting any extra money toward those with the highest interest rates. Alternatively, the “snowball” method is about building psychological momentum. Again, you’re paying the minimum for all your debts, but this time you use any extra funds to clear the smaller debts first. Each has pros and cons: the avalanche method reduces the interest paid over the long term, while the snowball strategy provides quicker wins to motivate you to stick with your repayment plans.
Are There Tax Implications for Debt Repayment?
Yes, there often are. For example, student loan interest is often tax-deductible up to a certain amount for eligible filers. On the flip side, forgiven debts may be considered taxable income. It's essential to consult a tax advisor to understand the all the tax implications related to your specific debt situation.
The Bottom Line
Repayment refers to paying back money that you have borrowed. Loan repayments cover a part of the principal, or the amount borrowed, and interest, which is what the lender charges for supplying the funds. Loan agreements specify the repayment terms, including the interest rates to be paid. When taking out a loan, borrowers should pay close attention to the repayment policies and only agree to take on the debt if they are confident they can make on-time repayments. Failing to do so can result in a cascading set of adverse financial consequences.
