For 15 months now lenders have been forced, by amendments to existing laws, to allow us to make partial overpayments on unsecured personal loans.
In addition, lenders must usually allow us to do so for free; they're not allowed to charge us penalties or admin fees. According to one government department, the same applies to full settlement of loans too.
Why weren't we told earlier?
However, even now, comparison websites and financial articles state that overpayments are not normally allowed.
Many lenders have resisted updating their marketing materials or they have gone from saying you can't make overpayments to saying nothing at all.
Some of them probably don't even know about these latest amendments to the Consumer Credit Act. Just a few months ago, one of the major peer-to-peer lenders was still boasting that it's one of the only major lenders to allow overpayments.
I hope not, because then lenders are ignoring the law.
But is it true?
I first uncovered this and wrote about it on this website as the changes took effect early last year but, as far as I've seen, there has been complete silence from lenders, the media and consumer groups since then.
It makes me nervous when that happens. However, the Department for Business, Innovation and Skills (BIS) has confirmed to me that my understanding of the law is true: we can now make overpayments, and usually without penalty.
How to make overpayments
The law is specific about how overpayments work, which loans it affects, and how we must go about making overpayments.
Firstly, unsecured loans taken out before 1 February 2011 are not affected. You can only make overpayments if the contract specifically says you can. However, you could take out a new loan to repay the old one in full. You might take a hit on penalties, but you should more than make up for that when you overpay your new loan more quickly.
With unsecured loans taken out after 1 February 2011, thanks to the new law, you can make overpayments without penalty in almost all situations.
However, unless your contract with the lender offers an easier way, you have to give notice to the lender before making an overpayment. You could tell them on the phone, but by writing or email is safer.
Then, you must make the overpayment within 28 days of giving notice.
Find out what your new position is
At the same time as giving notice, or later, you can ask your lender to tell you what the effect of the overpayment is. The lender doesn't have to respond until the overpayment is made, but must then do so within seven days.
The lender must write to you to say your new balance and what penalties it has charged.
When you might pay a penalty
My understanding of the law, and the understanding at the BIS too, is that you might have to compensate the lender, but only in extreme circumstances. All three of the following must happen before you have to pay a penalty:
- You have to overpay more than £8,000 in a 12-month period.
- Something must be significant about the particular time you make the early repayment. This might be that interest rates on new loans at the time are lower, so the lender gets less from re-lending the money.
- Over and above points one and two, the lender must still demonstrate the penalty is fair and objectively justified.
What penalty might you pay in those extreme circumstances?
Penalties cannot exceed 1% of the overpayment, or 0.5% if there is less than a year left to run.
[SPOTLIGHT]However, you could avoid even the possibility of a penalty by overpaying no more than £8,000 in a 12-month period.
Alternatively, you could split the overpayments. If you pay £9,000 off in one go, the lender might be able to take 1% of the lot, which is £90. But overpay £8,000 first and then £1,000 second (not the other way round) and the lender could only take 1% of £1,000, which is £10.
That's probably going to be far cheaper than waiting 12 months to overpay again.
Full settlement
We have been allowed to settle loans in full for some time, but lenders have usually charged a penalty. The BIS's interpretation of the law is that, on loans since February 2011, full settlement of unsecured loans must also be penalty free under the same conditions as above.
This means that all lenders who are still claiming we must pay a penalty for settling early in full probably have it wrong.
There may be trouble ahead
I wouldn't be surprised if many bank staff don't know about the new rules. Banks might not have processes in place to correctly deal with the overpayment, nor be aware of the fact you shouldn't pay a penalty. Some lenders probably don't have a system in place to tell you your new balance within seven days of the overpayment.
If you have trouble, complain to your lender that it has not followed the recent changes to the Consumer Credit Act, as implemented by the Consumer Credit (EU Directive) Regulations 2010.
If the lender still doesn't satisfy your complaint, and you feel you're being treated unfairly, complain to the free Financial Ombudsman Service. This Ombudsman could force the lender to compensate you.
If you have the stomach for legal jargon, read up on the laws. See the new section 95A of the Consumer Credit Act and the amended section 94. (Amendments are shown in square brackets[].)
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