Should I make partial pre-payments on an actuarial loan?
I discovered today that a loan I took out for home improvements doesn't use simple interest. I'm pretty frustrated with myself for not realizing this before I signed for it. Regardless, I'm trying to figure out if paying more than my minimum monthly payment (in an effort to save interest) is worth it.
It's a 15 year loan at 13.99%. My monthly payment is 5.80 and the amount financed is ,900. I've made 22 payments so far. Here's what my contract says with regards to prepayment:
Buyer can prepay any amounts due under this Contract at any time. If Buyer prepays this Contract in full, Seller will refund the UNEARNED FINANCE CHARGE figured by the Rule of 78ths method if the term of this Contract is 61 months or less, and by the Actuarial Method if the term is over 61 months. Seller or holder may retain an acquisition charge of . No refunds will be less than .
So, are partial pre-payments worth it?
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The contract is not very clear. As much as I can understand it will still help if you make part prepayments.
In an Rule 78 or Actuarial method, the schedule is drawn up front and the break-up of interest and principal for each month is calculated ahead. At the beginning both the reducing balance method as well as Actuarial method will give the same schedule.
However in Actuarial method, if you make part prepayments, they get applied to the future principals, the interest are ignored. However the future interests are not reduced.
Example:
Say your schedule looks something like this;
Monthly Payments say 100;
Month | Principal | Interest
1 | 10 | 90
2 | 20 | 80
3 | 30 | 70
4 | 40 | 60
5 | 50 | 50
6 | 60 | 40
7 | 70 | 30
8 | 80 | 20
9 | 90 | 10
So lets say you have made 3 payments of 100, in the 4th month if you make 150 [in addition to 100], it would get applied to the principal of 4th, 5th and 6th month. So essentially you would save interest of 4th, 5th and 5th month. It would also reduce the total payments to 6. i.e. you will only have 7th, 8th, 9th due. The next payment you make of 100 will get applied to row 7.
The disadvantage of this method over reducing balance is that the interest calculated for rows 7,8,9 don't change compared to reducing balance.
However if you prepay in full, the unearned interest is calculated and returned as per the Actuarial Tables.
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