The most popular financial product is a personal loan, whether it is used for a wedding, vacation, festival, or gadget buy. They don’t need security and are dependable, flexible, and simple to get. It is one of the most expensive despite being simple.
Many borrowers consider prepaying or foreclosing their existing Personal Loans due to the high-interest costs and EMI burden associated with them. While Personal Loan prepayment is usually a good idea for borrowers, they should do a thorough cost-benefit analysis to guarantee a sound decision.
How can you maximize a Personal Loan’s benefits while lowering its cost? The answer is prepayment. In this blog, we will discuss how prepayment of Personal Loans works.
What is Prepayment?
Prepayment is when you pay off your outstanding loan amount in whole or part before the loan’s due date. The prepayment clause specifies that if you pay off your loan before the agreed-upon term, the lender will charge you a fee equal to a percentage of the total loan amount, i.e., foreclosure charges on the Personal Loan. The prepayment charges on Personal Loans vary from lender to lender.
Paying Off the Debt Ahead of Schedule May Feel Free, But is it Always the Best and Most Cost-Effective Option? Let’s Find Out
Full Prepayment
A Personal Loan typically has a one-year lock-in term, after which you can prepay the entire balance, saving a significant amount on interest. However, you will still pay interest if you pay in advance. The rates may differ from one lender to another, ranging from 3% to 5%. You might be surprised to uncover public or private lenders and lending institutions that don’t have foreclosure charges on Personal Loans. As a result, in a cash emergency, you can get instant cash loan without burning a hole in your wallet due to excessive interest rates.
Part Payment
You might choose a part payment option if you have available cash that is insufficient to cover the total outstanding principal amount but can significantly reduce your loan burden. It can reduce the amount of owed principal, lowering your EMIs and real interest. If you choose this option, make a partial payment as soon as possible to save money by lowering your interest rate.
Debt-Free
To live a debt-free life, most borrowers will choose the prepayment option. Apart from the economic effects, it will relieve you of the burden of making monthly payments for many years.
Understand Pros And Cons Of Personal Loan Prepayment & How It Works
So, clearing debt before the end of your term seems a wise way to relieve financial stress. Let’s look into the pros and cons to assist you in deciding.
Pros of Prepayment
Interest Cost Savings
Paying off a Personal Loan saves the borrower’s money on interest costs that they would have paid if the loan had been kept open for the entire period. Let’s understand how to calculate the foreclosure amount of a Personal Loan. For instance, the EMI will be Rs.22,753, and the total interest cost will be around Rs.3.65 Lakh if a loan applicant seeks a Personal Loan of Rs.10 Lakh for a 5-year term at a 13% annual interest rate. They will save roughly Rs.2.09 Lakh in interest expenses if they settle the outstanding loan amount after one year.
Many Personal Loan borrowers believe they may save money on interest solely if they pay off their loan early in the term. Looking for a Personal Loan without prepayment charges can also help save funds.
The borrower can also save money on EMI payments if they pay off their debts sooner rather than later. To calculate the overall interest savings on a Personal Loan owing to prepayment/foreclosure, they should use an online Personal Loan prepayment calculator. Borrowers should, however, consider prepayment fees and other additional expenditures (if applicable) when calculating the net savings from using the prepayment option.
Increase Borrowers’ EMI Affordability
Banks/NBFCs like to lend to Personal Loan applicants whose total EMIs, including existing EMIs and the EMI for new loans, are less than 50% – 60% of their total monthly income. As a result, customers surpassing this limit have a decreased probability of getting a Personal Loan.
Prepaying an existing Personal Loan and thereby reducing their EMI/NMI ratio within 50%- 60% of their monthly income can help these borrowers improve their loan eligibility. A Personal Loan with no prepayment charges is also offered by some lenders.
Reduces the share of Unsecured Loans in the Credit Mix
The credit mix is the proportion of total outstanding secured and unsecured loans or other credit facilities.
Borrowers with a diversified credit mix in their loan portfolio get higher CIBIL score from credit bureaus.
Because Personal Loans are unsecured, they will reduce the proportion of unsecured loans in the credit mix if they repay them early. As a result, a higher percentage of secured loans might boost borrowers’ credit scores, increasing their chances of getting another loan. Borrowers can leverage a Personal Loan with a prepayment option to be on the safer side.
Increasing your CIBIL Score
Full foreclosure or payback of a current loan is a significant credit booster because it raises your CIBIL score and establishes a clean credit history. It will immensely assist you in obtaining loans and negotiating conditions with lenders in the future.
Also Read: What is Part-Payment, Pre-Payment, Pre-Closure?
Cons of Prepayment
Having to Make Large Payments
Prepaying a Personal Loan, despite its advantages, comes at a high cost: you’ll have to make lump-sum payments to erase the balance, limiting your financial flexibility temporarily.
Prepayment Penalty Fees
The RBI has prohibited all lenders from charging prepayment fees on Personal Loans with adjustable interest rates. On the other hand, borrowers who take out Personal Loans with fixed interest rates are not subject to this restriction.
Prepayment penalties of up to 5% of the outstanding principal amount of a personal loan are common. Prepaying a Personal Loan at a fixed rate can diminish interest savings. Many lenders also prohibit part-payments or foreclosure charges on Personal Loans until they receive several payments.
Negatively Impacting Liquidity
Many borrowers deplete their liquid assets or existing investments to repay their loans. However, doing so may jeopardize their ability to deal with any financial emergency that arises from events such as loss of income, medical troubles, or other unforeseen circumstances.
Borrowers may have to take out loans at a higher interest rate to accomplish unavoidable financial goals if they tap into current investments for that purpose. Existing Personal Loan customers should only choose prepayment if they have sufficient emergency finances to avoid this issue. They should also refrain from leveraging existing investments for unavoidable financial objectives.
So, before you decide to foreclose or prepay your loan, consider these variables and carefully consider the prepayment penalties, additional interest, and whether or not it would benefit you.
Conclusion
Prepayment is when you pay off your outstanding loan balance in part or entire before the end of your term.
Existing borrowers will find prepayment of a Personal Loan appealing because it helps them minimize their interest payments and overall repayment load. However, if the lender imposes prepayment penalties and a reduction in liquidity, this can be a deterrent.
Borrowers with limited liquidity can lessen their repayment burden and interest costs by refinancing the Personal Loan with a lender that offers lower Personal Loan interest rates.
Some Frequently Asked Questions
1.Is prepayment of a Personal Loan a good idea?
For those who want to get rid of debt quickly, prepayment of a Personal Loan can be a great option. It also helps in boosting your credit score and increases EMI affordability.
2.Are there any prepayment charges on Personal Loans?
Prepayment charges of 5% plus applicable taxes are levied upon Personal Loans with fixed interest rates. In the case of Personal Loans with adjustable interest rates, no charges are applicable. With Credit success, we have 0% foreclosure charges if paid from own sources.
3.Is it really beneficial to make partial payments to your Personal Loan?
If you lack funds for the prepayment of a Personal Loan, you can always opt for part payment. This will significantly reduce your outstanding loan amount and will help you plan your upcoming EMIs.
4.Can I prepay my Personal Loan at any time during the loan tenure?
Personal Loans come with a lock-in period of 1 year. Post that, you can pay the remaining amount of the loan and save on interest.
5.Will part prepayments reduce my EMI amount?
For individuals who are taking a Personal Loan, prepayment of their existing loans might increase their loan eligibility.
