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.
Due to the high-interest rates and onerous EMIs attached to personal loans, many borrowers think about prepaying or foreclosing on their current loans. Borrowers should perform a thorough cost-benefit analysis before making any decisions on the prepayment of their personal loans, even if this is generally a good idea.
How can you increase the advantages of a personal loan while minimizing its costs? Prepayment is the solution. We will talk about the prepayment process for personal loans in this blog.
What is prepayment?
When you prepay a loan, you settle the balance in full or in part before the loan’s due date. According to the prepayment provision, the lender will charge you a fee equal to a percentage of the total loan amount, or foreclosure fees on the Personal Loan, if you pay off your loan before the predetermined time has passed. Lenders have different prepayment fees for personal loans.
There is normally a one-year lock-in period on a personal loan, after which you can prepay the full sum and significantly reduce your interest costs. Even if you pay in advance, interest will still be charged. The rates may vary from 3% to 5% depending on the lender. Discovering governmental or private lenders and lending organizations who don’t charge foreclosure fees on personal loans may surprise you. As a result, you can obtain immediate cash in times of need without draining your bank account due to high personal loan interest rates.
If you have cash on hand but it isn’t enough to pay off the entire amount of principal that is still owed but it can greatly lessen your loan load, you might opt for a partial payment option. It can lower your principal balance, which will lower your EMIs and actual interest. If you decide to go with this route, try to cut your interest rate as quickly as you can to save money.
The majority of borrowers will pick the prepayment option in order to live a debt-free life. In addition to having a positive impact on the economy, it will free you from the strain of long-term monthly payments.
Pros and cons of personal loan prepayment
Pros of prepayment
Many people who take out personal loans think that paying off their debt before the term is up will only save them money on interest. Saving money can also be achieved by looking for a personal loan without prepayment fees.
If the borrower settles their obligations sooner rather than later, they can also save money on EMI payments. They should utilize an online personal loan prepayment calculator to determine the total interest savings on a personal loan as a result of prepayment/foreclosure. The net savings from adopting the prepaid option should, however, take prepayment fees and other additional costs (if applicable) into account.
Increase borrower’s EMI affordability
Banks and NBFCs prefer to lend to applicants for personal loans whose combined EMIs, including those for previous loans and the new EMI, are less than 50% to 60% of their entire monthly income. Customers who exceed this limit consequently have a lower chance of being approved for a Personal Loan. These borrowers can increase their loan eligibility by prepaying an existing personal loan and bringing their EMI/NMI ratio within 50%–60% of their monthly income. Some lenders also provide Personal Loans with no prepayment fees.
Reduces the share of unsecured loans in the credit mix
The ratio of total outstanding secured and unsecured loans or other credit facilities is known as the credit mix. Credit bureaus give higher credit scores to borrowers who have a diverse range of credit in their loan portfolio.
Since personal loans are unsecured, early repayment will lower the percentage of unsecured loans in the credit mix. A bigger proportion of secured loans may thereby improve borrowers’ credit scores, enhancing their prospects of obtaining additional credit. To be on the safe side, borrowers can choose a personal loan with a prepayment option.
Increasing your credit score
Because it boosts your CIBIL score and establishes a clean credit history, full foreclosure or repaying a current loan is a big credit booster. It will be of great help to you in the future when you are requesting loans and negotiating terms with lenders.
Cons of prepayment
Having to make large payments
Despite its benefits, prepaying a personal loan has a significant cost because you must make lump-sum payments to pay off the balance, which will temporarily reduce your financial freedom.
Prepayment penalty fees
All lenders are not permitted by the RBI to impose prepayment penalties on personal loans with adjustable interest rates. On the other hand, this limitation does not apply to borrowers who take out Personal Loans with fixed interest rates. Prepayment fees on personal loans that might reach 5% of the total principal balance are rather typical. Interest savings may be reduced when prepaying a personal loan with a fixed rate. On Personal Loans, many lenders additionally forbid partial payments or foreclosure fees until they have received many installments.