Retained Interest & Payout Penalties Explained
The hidden charge that could cost you thousands
When you finance a car (or other vehicle) with a business-related car finance facility - such as a Finance Lease, Commercial Hire Purchase (CHP), Chattel Mortgage or Novated Lease - you are exposing yourself to a hidden penalty if you choose to payout the loan early.
This hidden charge is known as "retained interest" or a "payout penalty", and is applied by almost every vehicle financier in Australia. The worst part is, payout penalties can amount to thousands of dollars, and you probably won't even be aware that you are paying them.
Stratton Finance is one of only a handful of finance companies that can offer business-related car finance with absolutely no retained interest payout penalties.
So, read on to find out what retained interest and payout penalties are, how much they can cost you, and how to avoid them - and once you're done, try out our Payout Penalty Calculator to explore exactly how retained interest could affect you.
So, what is retained interest exactly?
When you borrow money to buy a car or commercial vehicle, the lender makes their profit by charging interest on the loan. When the loan is setup, the total amount of interest payable for the term of the loan is calculated, and this interest cost is then spread across the repayments you make over the life of the loan.
Therefore, each time you make a repayment, a portion of it is used to repay principal (the actual funds you borrowed), and another portion is interest.
This means that if you payout your loan early the lender does not receive the full amount of interest they originally calculated for the loan, as some of this interest would have been included in future payments that you will no longer be making.
To recover some of this "unpaid future interest", lenders include a portion (or sometimes all) of it into your payout figure.
So, if you payout your contract early, rather than your payout figure being only the remaining principal (money actually borrowed) of your loan, it will be the remaining principal plus some (or all) of the interest the lender would have received if you had continued with the loan for the full term.
This is "retained interest" - unpaid future interest added to an early payout figure, slugging you with a "payout penalty".
It's also worth noting that you won't see the "retained interest" or "payout penalty" advertised along with other fees and charges associated with a loan - they are normally hidden deep within the Terms & Conditions of the loan contract. You won't even "see" them if you payout a loan early - you'll simply be given a single payout figure, which includes both the remaining principal and the payout penalty you're being forced to pay.
How much retained interest will I have to pay?
The amount of retained interest included in an early payout figure depends on a number of factors, including the amount borrowed, residual value, interest rate, length of the loan, the point at which the loan is paid out and the amount of interest retained by each particular lender.
As you can see, there are a lot of variables involved, many of which are unique to each loan and each lender. To better explore how much retained interest could cost you, we'll look at some worked examples based on common scenarios.
All of the following examples are based on the following loan scenario:
We're going to look at three different examples, which demonstrate the effect of retained interest / payout penalties in some possible scenarios.
Our first example is a "worst-case" scenario - a lender which retains 100% of unpaid interest (which several Australian banks do), and an early payout at month six.
Secondly, we'll look at an "average" scenario - our research shows that the average car finance contract is paid out at month 27, and that the average vehicle finance company in Australia retains about 50% of unpaid interest (50% payout penalty).
Finally, our third scenario shows the effect of retained interest on a payout quite close to the end of the loan's original term, again with the "industry average" 50% retained interest figure.
As you can see, retained interest payout penalties can add a significant amount of money to an early payout figure. It's interesting to note the difference retained interest makes on a month-by-month basis if you spread the payout penalty back over the payments already made (treating it as a monthly fee, rather than a lump-sum at the end).
You can also see how a payout penalty increases the effective interest rate of a loan - this is because the payout penalty is an additional cost over and above the "normal" interest charges which the original quoted interest rate is based on.
The effect of retained interest on our first example is quite shocking to see - the payout figure at month six is $8,520.80 more than the amount that was originally borrowed! This is because you are paying back the remaining principal of the loan ($38,499.11) plus a retained interest penalty consisting of all of the interest you would have paid if you had continued with the loan for the full term (another $10,021.69)!
And that's on top of the fact that seven repayments of $613.60 have already been made, so in this case the total cost to borrowing $40,000 for only six months would be a whopping $12,816.00!
Admittedly this is a fairly extreme example, but it's certainly not uncommon. All too often we speak to people who are in a situation just like this, stuck with a huge payout because they bought a car they no longer want, lost their job or had their vehicle written off (bearing in mind that most insurance policies only cover the market value of the vehicle, not the finance payout amount).
In our second example, the "average" scenario, the size of the payout penalty is much smaller but still very significant - it would still cost you $1,848.87 of retained interest to get out of the loan early. This is over $68 per month extra on a month-by-month basis, which is the equivalent of paying an interest rate around 12% rather than the "quoted" 9%!
Our third example shows how retained interest charges continue to decline as the loan gets closer to the end of the original term, but even at this late stage it would still cost you around $650 in payout penalties if you decided to (or were forced to) change vehicles early.
But they said there's no payout penalties!
Unfortunately, retained interest is a poorly understood concept, even amongst people who work in the vehicle finance industry.
Most banks and finance companies do not charge a fixed dollar fee when paying out a finance contract early. So, when you ask your dealer, broker, bank, finance company, etc. about "payout penalties", they often assume you are referring to a payout fee, and truthfully (in their mind) answer that there isn't one. This confusion is further compounded by the fact that "payout penalties" is a fairly ambiguous term.
This lack of understanding means that instead of simply asking about "payout penalties", you need to be very specific about what you ask and very careful about getting a favourable response. We suggest something along the lines of:
"If I choose to payout my finance contract early, will you unconditionally rebate 100% of unpaid interest?"
Be cautious of "I'm not sure", and vague or non-committal answers - you should also request an answer in writing before signing any documents.
The word "unconditional" is also particularly important in the above question - some lenders will charge you no retained interest if you payout early, but only if you finance your next car through them as well. This is known as "golden handcuffs" and it is not a good situation to be in, as you may end up stuck with a choice between a high interest rate on your next car or a hefty payout penalty.
So is there any way I can avoid payout penalties?
As we mentioned earlier, almost every bank and vehicle financier in Australia charges retained interest when you payout a business-use vehicle finance facility early.
There is, however, an exception - one finance company charges absolutely no retained interest when you payout your finance early - they charge no payout penalties.
Why doesn't this company charge a penalty? Because they are owned by a car manufacturer, and their finance products are not about maximum profit, but are instead designed to help sell cars - which includes making it as cheap as possible for clients to payout the finance on their current car and buy a new one.
Stratton Finance is lucky to be amongst only a handful of dealers and brokers around Australia that have access to this exclusive financier. This means we can offer our clients car finance with absolutely no retained interest charges or payout penalties. And to top it off, this same financier's interest rates are very competitive and they have no ongoing fees or charges.
If you'd like to know more about our finance packages with no payout penalties, please send us an online enquiry or give us a call on 1300 STRATTON (1300 787 288) and one of our finance consultants will provide a tailored quote and answer any questions you may have.
How much will no penalty payouts through Stratton save me?
The amount of retained interest contained in the payout figures from our earlier examples shows just how significant retained interest charges can be.
Let's return to those examples, and see how much money you would save in each scenario if you had financed through Stratton Finance with no payout penalties:
As you can see, the difference is huge.
But I'm not going to pay my finance out early
We hear this a lot - but unfortunately, despite best intentions, it doesn't always come true. We talk to a lot of people who swear black and blue that they will keep their car for five years, but then change it much sooner.
That being said, if you do keep your vehicle for the life of the loan then having no payout penalties will not make any difference to you.
But, if for any reason you decide to or are forced to payout early - you want a change, became sick or unemployed, need a new car because you've had a child (or extra children) or your vehicle is written off - then no penalty payouts can save you thousands of dollars.
Would you like to find out more, or get a quote?
If you'd like to know more about retained interest and penalty payouts, please send us a quick online car finance enquiry and one of our finance consultants will contact you shortly, or call us on 1300 STRATTON (1300 787 288).
We're able to provide a complete schedule for any loan scenario showing exactly what your payout would be at every month along the way, and how much retained interest you would save with no penalty payouts.
You may also want to try out our Payout Penalties Calculator to further explore the effect of retained interest payout penalties yourself.
For your convenience, you can also get an online quote for car finance with no penalty payouts in around 60 seconds - click here to get a quote now.