To fulfil a variety of needs in life, one applies for a loan. These loans range from business loans to personal loans to auto loans to student loans to mortgages and more. The loan’s repayment is the next major obligation after being granted. A unique interest rate is associated with each form of loan.
In order to pay off the loan amount over a predetermined period, borrowers must make an installment payment and interest each month. Some borrowers find paying interest to be financially taxing. If that is the case, customers have the option of prepaying the debt entirely or in part. You must comprehend loan payback conditions to take advantage of whatever repayment schedule you choose.
What is Part-Payment of a Loan?
First, let’s understand the part payment meaning. The part-payment of a loan happens when the borrower has some idle money, not equal to the entire outstanding principal amount. The borrower deposits this amount in the loan account to reduce the unpaid principal amount. As a result, the EMIs and the total interest you pay reduce. However, it is vital to note that you can benefit from this repayment schedule only when you spend a significant amount of lump sum money as part payment.
Part-payment of your loan helps you by reducing the principal amount. This, in turn, reduces the interest charged. On the whole, you end up lightening your overall EMI burden by a certain amount. Hence, it is always advisable to go in for part-payment of a loan whenever you have surplus funds.
Part-payment is an easy and effective way to reduce interest. The part-payment amount is deducted from the principal outstanding when you make the partial payment. After minimising your interest outgo, the savings you earn depend on the timing and amount of the part payment. It is not good to make a small part payment, especially if the bank or the lender has prepayment charges.
Part-payment of a Personal Loan has another advantage. You can make a part payment several times, depending on your capability. Some borrowers make a partial payment more than once, while others make a regular payment of a lump sum amount. Part-payment will reduce your EMI amounts, and total interest paid irrespective of the payment frequency.
If your bank or financial institution levies prepayment charges on every transaction, you can still benefit by paying back a substantial amount regularly. The interest you save on the whole will be much more. The only drawback in part-payment is that banks may not permit you to do so on specific types of loans, especially Personal Loans. They set a lock-in period on the term and the part payment amount.
Also Read:- A Brief Guide to Personal Loan Part-Prepayment
What is Prepayment of a Loan?
Prepayment is a facility that lets you repay the loan in part or full, before the end of the loan tenure. Most banks allow you to prepay the outstanding principal amount after one year. This repayment schedule helps you save a lot on interest. Let us understand this with the help of an example.
Ajay takes a loan of Rs 3 Lakh for five years at an interest rate of 15% per annum. His equated monthly instalments are Rs 7,137. He pays an interest of Rs 35,529 in the first year. The outstanding principal amount after the first year is Rs 2,64,160. On prepaying the outstanding amount, he saves interest of Rs 57,049.
The prepayment option lets you save on interest and get out of debt early. Moreover, the bank or the lender may reward you if you prepay your Personal Loan. For instance, banks provide value-added services like a free trading account or a zero-balance savings account to borrowers who choose prepayment.
However, some banks impose a penalty of 2% to 5% for loan foreclosure. This fee is charged on the outstanding principal amount. You can better understand the figures by using an online EMI calculator. The calculator estimates the cost of the loan and your savings with the prepayment facility. Just fill in the loan amount, interest rate, tenure, processing fee, method of prepayment, and foreclosure charges to get the required results.
The Reserve Bank of India (RBI) has recently instructed banks not to charge any penalty on the pre-closure of loans. However, the amendment is restricted to loans taken on a floating rate only. Personal Loans are generally on a fixed interest rate, and therefore, the rule does not apply.
What is the Pre-Closure of a Loan?
Pre-closure or foreclosure of a loan refers to repaying the outstanding principal amount in a single instalment before the end of the loan term. The legal process helps in reducing interest liability significantly. Moreover, it aids in closing the loan account well before its tenure.
To foreclose or pre-close a loan, the borrower must apply to the respective lending institution or bank. The lender will calculate the foreclosure balance after considering the total outstanding obligations, the remaining term of the loan, and interest paid. If the calculations and the amount is satisfactory, you can pay off the amount and close the loan.
Depending on the lender’s terms, a Personal Loan usually has a one-year lock-in period. You can prepay the balance and settle the loan account after this time. Ensure you collect the “No-dues” certificate and original documents from the bank or lending institution after settlement.
In some instances, the bank or the lender forecloses the loan. The situation arises when the borrower cannot repay the loan amount and defaults on EMI. The lender auctions the borrower’s collateral. After the amount equivalent to the outstanding loan amount is raised, the lender forecloses the loan account.
Difference Between Part-Payment, Prepayment and Pre-Closure of A Loan
| Part-Payment of Loan | Prepayment of Loan | Pre-Closure of A Loan | |
| Principle amount | Reduces your principal amount | Reduces your principal amount | Full loan repayment |
| Interest Rate | Rate of interest remains same | Rate of interest will reduce | Rate of interest remains same |
| EMI | EMI will reduce | EMI will reduce | No EMI |
Effect on Credit Rating
When you make a part payment against your loan, it has a negligible effect on your credit score. It reduces the total loan amount and the interest, making it easier for you to clear the loan on time. But prepayment and foreclosure have a positive impact on your credit score.
Summing up
Many lenders are offering attractive loan options. However, borrowers do not want to be debt-ridden. They want to repay the loan at the earliest. Prepayment and foreclosure facilities allow them to get rid of the debt earlier and save on interest. When they invest their surplus money in their loan account, they reduce the outstanding loan amount, thereby lowering the EMI or the loan tenure.
FAQs
1.What is the difference between prepayment and foreclosure?
The term prepayment is used when a borrower prepays part of the loan before the end of the term, whereas the term foreclosure is used when a borrower repays the entire loan before the end of the tenure.
2.What is pre-closure in banking?
In banking, pre-closure occurs when a borrower prepays the loan amount before the completion of the loan tenure.
3.What is the difference between prepayment and part payment?
By using the part payment method, a borrower can reduce his/her monthly EMIs, and total interest paid. In case of prepayment, the borrower pays of the entire loan amount (principal + interest) and closes the loan.
4.Does foreclosure affect your CIBIL score?
No, a foreclosure of your Loan doesn’t affect your CIBIL score. However, if you are still building your credit score as a new or inexperienced borrower, then it makes sense to continue repaying for the entire loan duration.
5.Does part prepayment reduce EMI?
A part prepayment can result in reduced tenure or a reduction in your EMI amount.
