A bonus arrives, or you finally save a few thousand euros, and a loan is still running. The choices look simple: leave the loan alone, use the money to pay it down, or invest it. Each one is right in some situations and wrong in others, and the difference comes down to a few numbers you can check yourself.
This is the fifth step of our Money in your 20s reading path. It builds on splitting your salary and on how to price what you own, and it uses the same compounding ideas as our compounding guide.
What a loan payment really is
Each monthly payment on a standard loan has two parts: interest on what you still owe, and a slice of the amount you borrowed. Early in the loan most of the payment is interest, because the balance is largest. Every euro you repay early is a euro that stops generating interest for the rest of the loan. That is why a prepayment (an extra payment on top of the schedule) can save far more than its own size.
Two ways to use a prepayment
When you pay extra, you usually choose what the bank does with it. BCR lists the two main options:
- Keep the payment, shorten the term. Your monthly payment stays the same, but you finish sooner.
- Keep the term, lower the payment. The loan runs to the original end date, with a smaller instalment.
Take a €20,000 loan at 8% with 10 years left, so a payment of about €243 a month and about €9,100 of total interest if you do nothing. Now suppose you prepay €3,000:
- Shorten the term: the loan ends after 7 years 11 months instead of 10, and total interest falls from about €9,119 to about €5,983.
- Lower the payment: the monthly payment drops to about €206, and total interest falls to about €7,751.
Shortening removes more interest, because you keep paying the same amount against a smaller balance. Lowering the payment saves less interest but gives you breathing room every month. BCR notes that reducing the term produces the larger total saving.
Prepay or invest?
Paying down a loan earns a guaranteed return equal to the loan's interest rate: every euro repaid stops costing, say, 8% a year. Investing the same euro may earn more, or less, or lose money. So the question is whether you can expect to beat the loan's rate after tax, and whether you can live with the risk.
Here is the €3,000 example again, but scored by the money you hold at the original end date. Money freed by paying early is assumed to be invested too, otherwise prepaying would look free of opportunity cost. With a 5% after-tax investment return:
Prepaying wins here because the loan's 8% beats the 5% investment. The break-even is simple: prepaying beats investing while your after-tax return stays below the loan's interest rate, which is 8% in this example. If you expect 9% after tax, the order flips: investing the €3,000 ends with about €7,350, ahead of both prepayment options (about €7,040 when you lower the payment and invest the difference, and about €6,730 when you shorten the term).
That flip is also why a cheap, long loan can be a different story. On a €100,000 loan at 3.5% with 20 years left, a €10,000 prepayment saves interest, but if you could earn 6% after tax, investing the €10,000 ends well ahead (about €33,100 against about €26,800 for the better prepayment option). The 6% is the assumption doing all the work, and it is not guaranteed, which is why the decision is also about risk.
Use the calculator to try your own loan. Change the balance, rate and term, then pick a lump sum or an extra amount every month:
Check the fees first
Before prepaying, look for an early-repayment fee. Under Romanian law, as BCR describes it, you have the right to repay a consumer loan early, partially or totally, at any time, without justification (OUG 50/2010). For a fixed-rate period the bank may charge a commission of up to 1% of the amount repaid, or 0.5% if less than a year remains. During a variable-rate period the commission is zero, and many banks now charge nothing on standard consumer and mortgage loans issued in recent years. Check your own contract, because the terms depend on the loan and the bank.
The effect is small but real. A 1% fee on a €3,000 prepayment is €30, and it nudges the break-even return in the example from 8.0% down to about 7.9%.
The order of operations
Prepaying is not the first thing to do with spare money. A sensible order:
Never drain your emergency fund to prepay a cheap loan. A loan you can keep servicing is better than an unexpected bill you cannot cover, and extra repayment is hard to take back once the money is gone.
Run it on your real loan
The calculator above uses the figures you type in. A real loan has a bank-issued repayment schedule, month by month, with the actual interest and any rate changes. If you want to see the effect of an extra payment on yours, you can sign up for InvestPane, upload your bank's schedule, and run extra-payment scenarios against the real numbers. The AI assistant is there too, to talk through the options, such as shortening the term against lowering the payment. The free loan prepayment calculator is on its own page as well.
Common mistakes
- Ignoring fees. Check the commission, and the rule for fixed and variable rates, before you commit.
- Prepaying with your emergency fund. Keep three months of needs.
- Prepaying a cheap loan while carrying expensive debt. Always repay the most expensive debt first.
- Not choosing the option. Tell the bank clearly whether you want a shorter term or a lower payment, and ask for the new schedule in writing.
- Treating an assumed investment return as a promise. The comparison above depends on the return you plug in, and returns are not guaranteed.
Key takeaways
- A prepayment saves interest on the part you repay, which is why it can save more than its own size.
- You usually choose between keeping the payment (shorter term) and keeping the term (lower payment). Shortening saves more interest; lowering the payment improves monthly cash flow.
- Prepaying earns a guaranteed return equal to the loan rate. It beats investing while your after-tax return stays below that rate, and it is the better pick for high-interest debt.
- Check the early-repayment fee. In Romania, a fixed-rate period can carry up to 1% of the amount repaid (0.5% in the last year), a variable-rate period none.
- Build the emergency fund first, and never prepay with money you may need soon.
- Test your own numbers, and for a real loan, use the bank's schedule.
Educational only — not personalised investment advice.