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In the mind of the servicer and lender, they're doing me a favor by lowering my monthly minimum payment, yet really they're aggravated that I've been overpaying and am now considerably off of the 10-year plan I've implemented.

They'd like for me to take just as long to repay my debt so they can make just as much interest off me...

Are they actually doing something wrong by the letter of the law? No is my guess, but the ethics are a different story.

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38

No, I don’t believe this is illegal. I think you’ve already highlighted the reasons this is done:

  1. As a service to the borrower, it allows them to lower their payment if they choose.

  2. If the borrower does start making smaller payments, it means more interest charges for the lender.

The minimum payment is called “minimum” for a reason. Feel free to ignore the change and pay this loan off as quickly as you wish. Their lowering of your required payment shouldn’t slow you down or cost you more in any way, unless you let it by lowering your payments yourself.

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    Also to note, they may have done a recalculation based on the time period you had previously chosen automatically. Since you have a lower balance due to aggressive payment, your balance is aggressively lower so the division is a lower amount. – Anoplexian Apr 5 '18 at 17:59
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    It could be harmful to the borrower to lower the minimum monthly payment if other financial opportunities or obligations of the borrower are pegged to that minimum. For instance it might affect child support obligations or the minimum monthly payment for some other type of loan whose minimum floats with their ability to pay. These don't directly make it illegal in any way I'm aware of, but they might be causes for action if the loan contract didn't explicitly allow the lender to lower the minimum payment. – R.. Apr 5 '18 at 18:03
  • It’s not a service to the borrower; it’s a strategy they hope will increase their interest. – WGroleau Apr 5 '18 at 20:33
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    @WGroleau It is a service, it just happens to be a profitable one. That’s what businesses do; they provide services and make a profit doing so. – Ben Miller Apr 5 '18 at 20:35
  • Thanks Ben, the plus side, too, is now I can contribute more money to the highest interest rate loan... – pfinnigan Apr 6 '18 at 15:38
5

A Wall Street friend once admitted to me their greatest concern for investing in loans was prepayments, as it reduces the total interest they get. Congrats on your aggressive paybacks - very responsible of you!

As you pay more principal, in general, your standard payment should lower (my minimum payment did as I paid extra principal, though some may differ on the minimum). For instance, if we have a loan balance of $20,000 and we aggressively paid off $1,500 a month, after six months, we would have already paid $9,000 which would impact a standard payment and possibly the minimum payment. Even if we assume our loan of $20,000 originally had a high interest rate, a good chunk of that $9,000 would have gone to principal, so we would have "less" interest to pay. Numbers on a 6% loan - just to provide a numerical context:

  • $20,000 @ 6% with minimum payment being interest only equals $1,200 in interest a year, which is $100 per month.
  • We pay $1,500 a month or $1,400 in principal the first month and $100 in interest. This makes the principal balance after the first month drop to $18,600 and at 6% interest on $18,600 comes out to $93 a month, if it was a minimum payment of interest only. Consider our second payment of $1,500, $1,407 would now go to principal, dropping the principal balance to $17,193. If the minimum payment is interest only, in general the interest will drop.

If they lower the payment even more than just that, it may be what my friend mentioned - they're trying to encourage you to take as long as possible. Provided it's not forced, it may not be illegal.

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    This: I'd say it would be less ethical not to lower the minimum payment compared to extending the remaining balance over the time period. Paying some early doesn't shorten the terms of the loan: I have a ten year loan, but because I paid off half of it early, I have to pay the remaining amount in 3 years? – TemporalWolf Apr 5 '18 at 21:29
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    @TemporalWolf Well, yes, that seems perfectly reasonable to me (assuming 3 years is the time after which the loan would be paid off if you make future payments in the amount of the original minimum). The point is, I don't think there's any widespread agreement about which way is more ethical to alter the terms of a loan when you make extra payments, i.e. whether to reduce the time, reduce the minimum payment, or both. – David Z Apr 6 '18 at 0:55
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Legally would depend on the terms of your lending agreement.

Generally a lending agreement specifies the principal, and payment schedule (payments, and term period). Not all lending agreements allow pre-payment. If pre-payment is allowed the lending agreement will specify how pre-payments affect the payment schedule (reducing the future payments, or shortening the term period). Most agreements actually have both clauses to ensure the minimum payment does not go below some minimum ($10). Some lending agreements will also have similar terms allowing you to miss payments.

I think "they're doing you a favor", "they're aggravated", and raising it as an ethics question assumes far too much on their part. It's a standard contract they wrote up to be competitive with other institutions, and attractive to a wide range of borrowers. In a general sense they likely don't care about you whatsoever as long as you fulfill your obligations under the lending agreement.

Ethically it is completely open-ended. "They" are professionals from a dozen different specialties who have studied and continuously improved this thing for years from legal, financial, statistical, risk, sales, ethics, social, marketing, and every other perspective. They have meticulously crafted a system that offers borrowers flexibility to make both "good" and "bad" choices.

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