Personal Loan Prepayment

Pros of making prepayment of the personal loan are:

• Become Debt Free: The foremost advantage of repaying any loan is to become debt-free which is a significant relief for anyone. Personal loans can support you with a fund crunch, but it can put you in financial despair if the repayments are not appropriately handled. Therefore, use the surplus funds you have to repay your debt as early as possible. This not only makes you debt-free but also lightens the burden of paying EMI over the entire tenure of the loan.
• Save on the interest: It is advisable to make the prepayment in the early phase of the loan term if you have ample funds. However, it is essential to remember here that most lenders have some lock-in period. That means that within the lock-in period, you cannot repay your loan entirely or partially. However, you can make repayments after the lock-in term is over and save a decent amount of interest.

The drawbacks of making prepayment of Personal Loan are:

• Payment of foreclosure charges on personal loan: There is a caveat when you make repayment of the loan, i.e. personal loan prepayment charges. It is an amount paid by the borrowers if they repay the loan before the loan term ends. Personal loan prepayment charges vary from nil to 5 percent of the outstanding balance or a fixed amount from one lender to another. Some lenders may not charge any penalty from the borrowers, and some may charge a flat penalty or fixed percentage of the loan amount. You will save significantly on prepayment if your lender does not charge a prepayment penalty.
• The depletion of a large sum of cash: Having liquidity in hands is quite useful for its unfettered use. You can use it to satisfy your immediate fund needs or invest in a financial product that may get you better returns. It depends on your situation to determine how to spend your surplus funds – whether to pay your loan in advance or to use it in another place.

Note: Be sure you compare the different interest rates charged in the personal loan prepayment agreeing on a partial or full prepayment. Furthermore, select a personal loan deal that does not have a prepayment penalty or low charges and save as much as possible from prepaying the unpaid debt. Prepayment not only lowers the debt burden but also reduces the risk of defaulting on personal loans.

First, you have to check the lender's methodologies for calculating the prepayment prices to calculate the pre-closure charges for personal loans. Determine the exact balance of the unpaid amount. Contact the lender for an amortization plan; a paper detailing the payment schedule information and the balance capital for each payment to calculate the remaining balance. There are broadly two methods for calculating the prepayment penalty.

• Fixed penalty: In general, over a predetermined period of months, the lenders will levy a fixed penalty fee dependent on the interest rate. If the lender employs a fixed penalty payment form, the amount you are supposed to pay will be determined by the interest rate and the number of months multiplied by the remaining principal amount. For instance, if your balance principal is ₹ 2,00,000 and the interest rate is 6% and the predetermined months are six then multiply ₹ 2,00,000 x 0.06 = ₹ 12,000. Then ₹ 12,000/12 = ₹ 1,000 and ₹ 1,000 x 6= ₹ 6,000 will be the prepayment penalty.
• Differential Interest rate: Some use the interest differential approach based on a balance principal and the difference between the original and the new interest rate. When the lender charges a penalty based on the differential rate process, you can determine the prepayment penalty by calculating the difference between the initial and the new interest rates. For instance, if the initial interest is 7.5% and the new rate is 5.5%, the difference is 2%. First, multiply the principal with the difference percentage – ₹ 2,00,000 x 0.02 = ₹ 4,000. After that, divide the number of remaining months by 12 and multiply with the previous estimates. Divide by 12 and multiply by ₹ 4,000 if the remaining months' number is 24, then ₹ 8,000 will be the prepayment charges.

✅Is prepayment of personal loan a good idea?

It depends on your aim of prepayment. If you aim to save interest by making prepayment of the loan, it is useful to do it in the early phases or after the lock-in period. If you are prepaying the loan for improving credit score, then prepayment will bring you in good books of credit bureaus. Be mindful of prepayment charges levied by the bank.

✅Can I pay a personal loan in advance?

You can pay it in advance, although it is not advisable. Sometimes, lenders ask borrowers to pay 1-2 EMIs in advance before the loan is approved. Suppose you have taken a loan of ₹ 1 Lakh at 15% for two years or 24 months. The emi comes to ₹ 4,849. So, if you pay two EMIs in advance, the effective loan balance is reduced to ₹ 90,302. An EMI of ₹ 4,849 means that you have to pay more interest rate around 18% instead of 15%.

✅Does prepayment reduce EMI?

When you make a prepayment of your loan, your overall burden decreases, and you have two options in front of you. First, you have the option to reduce your tenure and second, you can get your EMI reduced. Which option suits your requirement depends on your convenience and financial situation.