What early repayment saves, product by product

The question behind the question

Paying early saves money only where the cost accrues with time. Where the cost was fixed at signing, paying early just delivers the same dollars sooner, which makes them more expensive per day, not less.

Work out which kind of product you have before you work out what to pay.

Simple-interest amortising debt: early repayment saves real money

Interest is charged on the outstanding balance, so a balance that disappears stops charging.

Illustrative only — $80,000 over 60 monthly payments at a 12% nominal rate. The payment is $1,779.56 and the total interest over the full term is $26,773.60.

Pay it off at month 24. You have paid $42,709.44, of which $16,287.32 was interest, and the payoff balance is $53,577.88. Total interest paid: $16,287.32. Interest avoided: $10,486.28.

Two things to confirm before relying on this. First, that interest is calculated on the outstanding balance rather than pre-computed. Second, whether there is a prepayment charge, and whether it is a percentage of the balance or a fixed number of months' interest.

Pre-computed interest: less than you would expect

Some equipment and small-ticket contracts add the whole interest charge to the balance at the start and then allocate it across the payments using the sum-of-the-digits method, often called the Rule of 78s. The allocation is front-loaded, so early payoff refunds less than a balance calculation would.

Illustrative only — $30,000 financed with $18,000 of add-on interest, repaid in 48 payments of $1,000. The sum of the digits for 48 months is 48 x 49 / 2 = 1,176. Paying off after 24 payments leaves 24 payments, whose digits sum to 24 x 25 / 2 = 300, so the unearned interest is $18,000 x 300 / 1,176 = $4,591.84. Payoff: $24,000 − $4,591.84 = $19,408.16.

For comparison, the periodic rate implied by $30,000 against 48 payments of $1,000 is 2.1096% a month, a 25.3% annualised rate. Discounting the remaining 24 payments at that rate gives $18,681.13. The sum-of-the-digits payoff is $727.03 higher — that is what the front-loading costs you at the halfway point, and it is larger earlier in the term.

Ask whether the contract uses a rebate method at all. Some do not, and the payoff is simply the remaining payments in full.

Fixed-total products: nothing, unless it is written down

On an advance priced with a factor rate, the amount owed is set at signing. Repaying in three months instead of six does not reduce it.

Illustrative only — $35,000 at a 1.32 factor repays $46,200 whenever you finish. Some contracts do carry an early payoff discount: suppose yours reduces the factor to 1.22 if the balance is cleared within 60 days. That is $42,700 instead of $46,200, a saving of $3,500.

The saving is real, and so is the price of the speed. Paying $42,700 for $35,000 in 60 days is a cost of $7,700 for two months of money — a 133.8% simple annualised rate, or 235.2% compounded. A discount is not the same thing as cheap.

If the contract is silent on early payoff, assume there is none and ask for the position in writing before you plan around it.

Invoice factoring: it depends how the discount is charged

Where the fee is a percentage per 30-day period, the structure matters more than the rate.

Illustrative only — a $10,000 invoice at 2% per 30 days. Paid on day 31, a tiered contract charges two full periods, $400. A pro-rata contract charges 31/30 of one period, $206.67. The difference on one invoice is $193.33, and across a book of invoices settling just past the period boundary it is the single largest variable in the cost of the facility.

Ask which method applies, where the boundary falls, and whether the clock starts at invoice date, funding date or notification date.

SBA loans: check the note

SBA's 7(a) program has applied a prepayment fee to loans with maturities of 15 years or more where more than 25% of the outstanding balance is prepaid within the first three years, at 5%, 3% and 1% in years one, two and three. Shorter maturities have generally not carried it. SBA 504 debentures have their own declining prepayment schedule.

Programme rules change, so read the note and the current SOP rather than a summary — start at sba.gov and ask the lender or CDC for the exact figures on your loan.

Revolving lines: small savings, repeated

Interest on a line accrues daily on the drawn balance, so repaying early saves in direct proportion to the days you removed.

Illustrative only — a $50,000 draw at 11%, repaid 22 days earlier than planned, saves $50,000 at 11% for 22/365 of a year: $331.51. Nine days early saves $135.62.

Individually trivial. Applied to every draw, twelve times a year, the 22-day version is $3,978 — more than most businesses save by negotiating a quarter-point off the rate, and entirely within your control.

Two mechanics decide whether any of that saving is real. Whether interest is charged on the daily balance or on an average or minimum balance for the period, because the second and third destroy most of the saving. And when a payment is actually applied, since a payment posted the following business day costs a day of interest every single time, which on daily-balance pricing is the whole game.

Most revolvers carry no prepayment penalty. Many carry an unused-line fee, so paying a balance down shifts a small part of the cost from the interest line to the fee line rather than eliminating it. Net of that, paying down early still wins comfortably.

Before you pay anything early

1. Ask for a written payoff quote with a good-through date. Verbal payoff figures move.
2. Ask what the quote assumes about accrued interest and fees.
3. Confirm in writing that the lien or UCC filing will be terminated, and by when.
4. On a fixed-total product, ask specifically whether the payoff is discounted, and by how much.
5. Compare the saving against what else the cash could do. Paying off 12% money early is a 12% return. Paying off a fixed-total advance early is a negative one.

The calculators will produce the amortising payoff figure and the sum-of-the-digits rebate; the rest is contract language.