A personal loan is granted to you by a lending institution (like a bank. NBFC, or other financial company) based on your capability to pay the loan amount on time, every time. Whereas there is a fixed tenure for every borrower to repay the loan amount, there’s also an available option called “ Pre-payment” that allows you to close your loan amount even before the end of the tenure. While most lenders do not charge prepayment penalty fees, you may still have a number of lenders willing to give you an advance loan amount – even before you have paid the first EMI. This is the new money the lender doesn’t really want to give out.
Pre-payment Charges – All the Good and Bad
Personal Loans can be a major lifesaver in a financial crisis. A pre-paid loan can be settled with the entire loan amount up front or in installments before the estimated due date. You may have arranged enough money for a later date to pre-pay the entire loan amount or even a part of it. But should you go ahead and prepay it? Here’s our take on when you should pay off your personal loan early and when you shouldn’t.
What is a Pre-payment on Personal Loans?
Banks offer Personal Loans to customers at a certain interest rate. This means customers repay the loan in installments over a period of time. Prepayment of a Personal Loan means paying off the entire outstanding amount or paying a part of it before the due date as per the agreement. The exact timing of prepayment is not necessary, and one can opt for it anytime. The bank levies charges on prepayment, which are called foreclosure charges when it comes to personal loans.
Advantages of Pre-payments on Personal Loans
There are many instances in which prepaying a Personal Loan makes sense. Here are some examples to illustrate the point.
Save Your Money: Thinking that you could get away with postponing the monthly EMI payments is the wrong approach, which will only increase your overall debt burden. In order to reduce the interest rates on your personal loan, you can prepay the loan, provided you get a refund for the extra amount paid. If not, it will add another layer of interest payment along with the one already due under your existing EMI schedule and may even take away some tax benefits if your annual income is above a certain threshold limit.
Boost Your Credit Score: Many people are not aware of the manifold benefits of prepayment of a personal loan. The two most important benefits, however, are that prepayment gets rid of your indebtedness and improves your credit score. Although the exact logic behind their impact on improving your credit score is not well understood, it is believed that prepaying a loan instils greater confidence in the mind of lenders, and you then have an improved chance of getting loans in the future.
Get benefits on Interest Cost: Interest is money paid to a lender for the services of lending the borrowed amount. It is paid in regular intervals till the loan maturity date. However, sometimes it makes sense to reduce interest rates or save on interest payments by paying off the loan early. A big chunk of your loan comes at an interest rate of up to 20% or above; you can save by paying it down before repaying it to avoid unnecessary costs.
Disadvantages of Pre-payment on Personal Loan
Financial Instability: Paying your loans in advance is a great way to reduce your monthly burden, but it also means taking money from your savings. The cash you use for paying off a loan is not always your own and can also belong to other sources. In short, prepaying a personal loan or balance transfer for your next loan can make things quite unpredictable financially, so don’t take such decisions lightly.
Affected Asset Liquidity: Be mindful if you plan to use your liquid assets for loan prepayment. You may be forced to dip into them in the future due to an emergency or some other unforeseen circumstance. So before liquidating your asset to pay the entire loan amount at once, think twice!
Extra Charges: If you want a personal loan that comes without any charges, this is one of the biggest problems with pre-payment. If you want to close the loan before its tenure ends, you will have to pay the foreclosure charges. The foreclosure charges are very minimal if compared to other Personal Loan charges, but they can make a difference when paying off your personal loan amount in one go.
Summing It Up
It is important to take a comprehensive look at your current financial situation before making a decision, and with that information, you should be able to make a more informed decision about which pre-payment option you choose. It is a good idea to read more about the pre-payment penalties and understand all consequences before you decide on your next step.
FAQs
No, you can find this feature with every bank or every loan option. It is a good option to confirm this with your bank beforehand.
Pre-payment fee is charged to recover the loss in rate of interest incurred by the bank due to prepayment by the borrower.
When you take out a loan, you may want to pay it off as quickly as possible. If you pay off the loan before its maturity date, your lender may charge you a fee called a prepayment penalty or foreclosure charge.