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Benefits of early loan settlement

Early loan settlement

Small businesses require funds to meet different business operating expenses and capture the scope of opportunities and growth. It is difficult for small businesses to meet the capital requirements after covering the business operating expenses. Thus, most small businesses depend on different types of loans to cover business capital requirements.[1]  Small business owners can take short-term and long-term loans for different business purposes.

Loan contracts include a loan repayment period within which the accrued loan principal and profit must be repaid. This load repayment period is the loan settlement period. When loans are paid before the stated loan settlement period, it is called early settlement of the loans.

A loan repayment before its due date has some key benefits such as the below:
Total cost savings:

Loan principal and profit are calculated based on the entire loan settlement period. If the business owner repays earlier than the due date, a part of the profit will be waived[2]. The sooner the debt will be paid, the less profit the business owner will pay. For example, if a small business owner has an outstanding loan of SAR50,000 at a 7% annual profit rate and a loan term of 1 year, the loan amortization will be like in the below table:

MonthMonthly paymentprofitPrincipalBalance
* Amount Thousands SAR

If the small business owner repays the loan after 1 year, the total profit paid will be $1916. In this case, If the small business owner repays the loan after 2 months, the total profit paid will be (SAR290+SAR268)= SAR560. Thus, there is a saving of (SAR1916-SAR560)=SAR1356. Therefore, small businesses can save money by paying less profit if the loan is settled earlier than its due date.

Improved credit score:

By paying off loans earlier than the due date, the business owner can improve their credit score since it reduces the risk of default. The early settlement indicates a responsible borrower and thus awarded higher credibility.

Opportunity for new financing:

Along with a higher credit score, early loan settlement helps to improve the debt-to-equity ratio of a business. Thus, with the early settlement, the borrowing power and credibility of the business increase which helps to get new loans whenever needed.

Alternate use of money:

Through the early settlement, the business owner saves money from less profit payment and free up business finances to use in business rather than loan installment. The business owner can invest in business growth and plan for long-term goals without worrying about debt payments.

Avoid the risk of default:

If the business owner delays the repayment of the loan, it increases the risk of loan default that might lead to business bankruptcy. Since the business life cycle is longer than the loan settlement period, the business will have to pay more profit which will increase cost and risk of default. Thus, by repaying the loan earlier, the business can reduce its debt and default risk.

Avoid late payment fees and obligations:

If the monthly installments of the loan are not made in time and the entire loan is not repaid within the settlement date, the business may face significant late payment fees and legal charges that can increase business expenses. Moreover, the management of loan installments requires time and labor. Thus, early loan settlement can help to avoid expenses in late payment fees and legal charges.

Small businesses are required to manage their business finances efficiently to reduce the cost and risk of bankruptcy. In this case, through early settlement, the company can improve their credibility, reduce financing costs, and achieve higher business financial strength. [3] The most common financial instrument for small business owners is invoice financing especially from those financial institutions that allow early settlement[4]  without any extra charges. For example, Lendo is a financing company that provides invoice financing to small and medium businesses, and it does not charge fees for early settlement. Thus, Lendo helps small businesses to enjoy the benefits of early settlement.

Lendo is a financing company that helps SMEs convert pending accounts receivables to cash right away. Lendo is the first financial institution to introduce a peer-to-peer (P2P) invoice financing platform in Saudi Arabia starting from 0.8 per month for small and medium-sized enterprises (SMEs). Small business owners can ask Lendo for financing advice and get expert suggestions on how to improve their financial position, optimize profits and strengthen financial condition. For more information about Lendo and its services, visit the website here.

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