Prepayment / early settlement

Prepayment is any repayment made ahead of the contracted schedule. Early settlement is the complete version: clearing the entire outstanding balance before the end of the term, closing the loan.

The distinction matters because the two produce different processes and different obligations.

Partial prepayment

• Amount paid: Above the instalment, but less than the full balance
• Loan status after: Continues, with a revised term or instalment
• Requires a quote: No
• Security / guarantors released: No

Full early settlement

• Amount paid: Entire settlement figure
• Loan status after: Closed
• Requires a quote: Yes — a settlement figure
• Security / guarantors released: Yes

Scheduled maturity

• Amount paid: Final scheduled instalment
• Loan status after: Closed
• Requires a quote: No
• Security / guarantors released: Yes

Partial prepayment mechanics — reducing the term versus reducing the instalment, and how payments are allocated — are covered under overpayment. The charge that may apply is covered under prepayment penalty. This page deals with the settlement figure itself and what has to happen when a loan closes early.

The settlement figure

The single most common misunderstanding about early settlement is that the amount payable equals the balance shown on the last statement. It does not.

A settlement figure is built up as follows:

   Principal outstanding
 + Interest accrued since the last payment date
 + Unpaid fees and charges
 + Penalty interest on any arrears
 + Prepayment / early settlement charge, if applicable
 − Rebate of unearned interest (flat-rate and pre-computed loans)
 − Refund of unearned credit life premium
 − Any credit balance or unallocated funds held
 = Settlement figure

Worked example. A borrower with $8,400 of principal outstanding at 18% per annum on a reducing balance, 14 days after the last instalment, on an Actual/365 basis, with a 2% early settlement charge and $45 of unearned credit life premium:

Principal                        8,400.00
Accrued interest (14 days)          57.99
Early settlement charge (2%)       168.00
Credit life premium refund         (45.00)
                                 ─────────
Settlement figure                8,580.99

The accrued interest line is why a settlement figure changes daily, and why it exceeds the statement balance.

Unearned interest and the rebate

How much a borrower actually benefits from settling early depends on how interest was calculated.

Reducing balance. Interest accrues on the outstanding balance as time passes. Nothing has been charged for the future, so nothing needs rebating — settling early simply stops further accrual. This is the cleanest case.

Flat rate or pre-computed. Total interest was fixed at inception and charged across the schedule regardless of actual balances. A borrower settling at the halfway point has been charged for time they will not use, and that unearned interest must be rebated for early settlement to have any value.

The rebate method determines how much comes back:

• Actuarial method — reflects true unexpired interest; the fairest calculation
• Rule of 78 — front-loads interest, refunding considerably less than expected at mid-term
• No rebate — the borrower gains nothing at all from settling early

On a flat-rate loan, the first question is not "what is the penalty" but "what rebate applies" — because a nil rebate is a far larger cost than any stated charge.

Quotes, validity and value dating

A settlement figure is a quotation valid to a specific date, because interest continues to accrue daily until funds actually land.

• Ask for the quote in writing, itemised, with the expiry date stated.
• Pay before expiry. Paying after it leaves a residual balance — usually small, often unnoticed, and a frequent source of "I settled my loan but the lender says I still owe money."
• Check the value date, not the payment date. A transfer initiated on the expiry date may credit a day or two later, past the quote.
• Request written confirmation of a zero balance once payment clears. This is the document that matters later.

What must happen after settlement

Settlement is not complete when the money arrives. A properly closed loan requires all of the following, and each is a known failure point.

• Settlement or discharge letter confirming a nil balance and the closure date.
• Release of security. Mortgage discharge registered at the land registry, charges released at the movable collateral registry, chattel registrations cancelled, title documents returned. Security left registered after settlement blocks the borrower from using the asset to raise finance elsewhere.
• Cancellation of collection instructions. Direct debits, standing orders and — critically — payroll check-off deductions. Deductions continuing after settlement are common, and recovering them takes months.
• Credit bureau update to closed or settled status. A loan reported as live after settlement distorts the borrower's exposure and can block new applications.
• Refund of unearned credit life premium, where cover was paid for a period that no longer exists.
• Return of any credit balance arising from overpayment or a settlement quote paid twice.
• Release of guarantors, in writing. Guarantors are rarely notified and often remain on record long after the obligation has ended.

Borrowers should keep the settlement letter indefinitely. It is the only proof that the debt was discharged.

Where the money comes from

• Cash or savings — the cleanest case, and the one where the interest saving is largest
• Sale of the financed asset — common in vehicle and property finance; the settlement figure determines whether the sale clears the debt or leaves a shortfall
• Refinancing — replacing the loan with another, where the benefit depends on the rate differential rather than the whole interest bill
• A top-up — the existing balance is settled from the proceeds of a larger new loan, which is settlement in form but not in substance
• An insurance claim — credit life or asset insurance settling the balance on death, disability or total loss

Prepayment from the lender's side

Early settlement is prepayment risk at portfolio level. It shortens the effective life of assets, causes interest income to undershoot forecasts built on contractual schedules, and — where funding is term-matched — creates a duration mismatch.

Practical responses:

• Model prepayment speeds and forecast on expected rather than contractual life
• Track settlement reasons. Settlements driven by competitor refinancing are a pricing signal; settlements from asset sales are not.
• Automate the closure checklist. Security release, deduction cancellation, bureau update, premium refund and guarantor release should be system-driven, not left to individual officers.
• Produce settlement quotes systematically, itemised and dated, rather than by manual calculation. Quote errors are among the most common sources of dispute and of unrecoverable write-offs.
• Respond with retention, not friction. Frustrating settlement through delayed quotes or unreleased security is a conduct risk and increasingly a regulatory one.

Common problems

• Quote excludes a rebate the borrower was entitled to
• Deductions continue after settlement, especially on check-off loans
• Security is never released, discovered only when the borrower next needs to borrow
• Bureau record stays open, overstating the borrower's obligations
• Guarantors remain liable on record long after discharge
• Residual balance from paying after quote expiry, accruing quietly until it becomes an arrears case