She further stated that she informed the bank of her intention and was advised that she would have to pay a penalty charge for paying off her loan earlier than originally contracted. The customer found this to be unreasonable since she approached another bank, where she had another loan, with a similar request and was offered a rebate.
The customer approached the Office of the Financial Services Ombudsman and was advised that when a higher purchase loan is offered to a customer for a specific period, interest is calculated over the period of the loan and added to the principal. The total is then divided by the number of months to repay the loan in order to determine the monthly installment. If the loan is paid off in full before the end of the period, the customer can normally expect to get a rebate on the interest added. However, if the loan is on the declining balance, there would be no rebate since the interest is only calculated and paid on the balance outstanding each month.
In most cases, if a customer decides to pay off a loan in full before the end of the termination date, a penalty charge is applied; the amount could be as much as a few months of interest. Theoretically, this is to compensate the banks for the imputed loss of interest during the time it would take them to un-lend the funds that would otherwise be loaned to the customer. This is typical of all loans and would usually form part of the items and conditions.
Before entering into a loan transaction, customers should ask the bank what penalty charges, if any, would apply if the loan is paid off before the expiry date and what other charges would apply, for example, penalty charges for late payment of installment.
Read the terms and conditions carefully and make sure that you fully understand the clauses, usually written in fine print, so that there are no surprises afterwards.