Is Personal Loan Pre-closure a Smart Financial Decision?

The main reason behind the increasing popularity of personal loans is that they can be availed within a few minutes to a couple of days with zero to minimum documentation. Besides, there is no restriction on the end use of the personal loan amount, making them an ideal option for a wide range of life's needs and situations, including purchasing a car, making a down payment for a home loan, financing higher education, addressing medical emergency, or even buying the latest smartphone, planning a vacation, and throwing a party!

While salaried individuals often opt for a personal loan during a financial crunch, their typical intention is to settle the personal loan upon receiving additional funds, whether it's in the form of a performance bonus, a gift, or when they've managed to save some extra money from their monthly budget.

Even if the borrower has borrowed just the right amount considering his/her financial requirements, income, expenses, and using a Personal Loan Calculator, he/she still wishes to get debt-free as soon as possible.

What Is a Personal Loan Pre-closure?

As discussed, borrowers with surplus funds often desire to expedite the repayment of their loans through part-payment or pre-closure.

Pre-closure of a personal loan, or in simple words, settling personal loans ahead of schedule, involves making a full repayment of your loan in one lump sum before the scheduled due date. This means clearing the outstanding amount all at once instead of making monthly instalment payments (EMIs).

Opting for a personal loan pre-closure can result in substantial savings on both the interest and EMIs that would otherwise be paid over the entire loan tenure. Nevertheless, it's worth noting that personal loan pre-closure may involve prepayment charges. Hence, it is advisable to thoroughly review the terms and conditions and understand their implications before opting for a personal loan pre-closure.

To better comprehend the personal loan pre-closure, let's understand the prepayment-related terms that borrowers often get confused with and use interchangeably. While these terms sound similar, they have completely different meanings.

[Click Here to Download Our Free Guide "Your Definitive Guide to Avail of Personal Loan in India"]

[Also Read: How to Use a Personal Loan Calculator Effectively A User-Friendly Guide]

Personal Loan Prepayment:

If you find yourself with extra funds, you have the option to utilise them for early repayment on your current loans, thereby reducing your debt load.

Loan prepayment is a service provided by banks and other financial institutions (lenders), permitting you to settle your loan before its scheduled maturity.

This prepayment can be either partial or complete, depending on your preference.

Personal Loan Part-payment:

Personal loan part-payment involves the practice of repaying a specific portion of your outstanding loan amount, often done when borrowers come into extra funds, like a bonus or a gift.

Part-payment is a more preferred loan prepayment option in the case of home loans with a floating interest rate, as home loan borrowers try to take advantage of situations when the home loan interest rates are at their lowest.

By making part-payments, borrowers can significantly reduce the overall burden of their personal loan. This approach encourages responsible financial management by advising against spending windfalls thoughtlessly and instead using them to reduce your debt.

It is crucial, however, to be aware of your lender's specific policies regarding pre-payment charges, as lenders usually impose fees for personal loan part-payments.

Personal Loan Pre-closure or Foreclosure:

As the name suggests, personal loan pre-closure denotes a legal procedure in which the borrower repays the entire outstanding loan balance before the loan's designated end date. It is also referred to as personal loan foreclosure.

Pre-closure delivers a substantial reduction in your interest outgo and enables you to free yourself from debt. Typically, financial institutions permit loan foreclosure after a specific duration, the specifics of which can vary among various loan types and lenders. If your loan qualifies for foreclosure, you can initiate the foreclosure process by submitting a request to your lender.

The lender will provide you with a quotation after assessing factors such as your outstanding balance, remaining loan term, and the interest you have paid. Upon approval, you can make the necessary payment for loan foreclosure and receive your original documents and a No Objection Certificate (NOC) from the lender.

Nevertheless, similar to personal loan part-payment, there might be associated charges with personal loan pre-closure, making it prudent to examine the terms and conditions carefully.

What Are the Benefits of Personal Loan Pre-closure?

The benefits of personal loan pre-closure are multifaceted and can significantly improve your financial situation:

1. Helps Reduce Your Debt Burden:

Opting for personal loan pre-closure or foreclosure is a powerful tool to become debt-free sooner. When you have multiple loans going on, cutting down even one EMI can reduce your debt burden and accelerate your journey to becoming debt-free, even in challenging financial circumstances.

2. Saves Total Interest Outgo:

The longer your loan tenure, the more interest you end up paying, especially when dealing with a substantial loan amount. Initiating personal loan pre-closure in the initial or middle stages of your loan can lead to substantial savings on interest payments. However, it's essential to weigh the cost of pre-closure charges against the interest saved in the later stages of the loan.

3. Reduces the Loan Tenure:

Personal loan pre-closure allows you to legally terminate your loan agreement, eliminating your liability towards the loan. If you are unable to foreclose the personal loan, even a part-payment can either lower your EMI while maintaining the loan tenure or reduce the loan tenure while keeping the EMI amount constant, giving you greater control over your financial commitments.

Top of Form

4. Helps You Maintain the Credit Score:

Pre-closure of a personal loan does not negatively impact your credit score. It is regarded as a loan paid within the specified tenure, which can be advantageous for your credit history. However, for individuals aiming to establish a strong credit history, consistent and timely loan repayments over a longer duration can be beneficial, provided the loan interest rate is on the lower side.

5. Ensures the Best Use of Surplus Money:

Rather than succumbing to the temptation of unnecessary expenditures, channelling surplus income and savings into loan pre-closure fosters financial discipline. This approach helps you achieve a debt-free status while simultaneously reducing your total interest expenses, ensuring that your financial resources are utilised wisely.

6. Helps Create the Right Credit Mix:

Your credit mix signifies the proportion of your outstanding secured and unsecured loans. Credit reporting agencies consider this mix when calculating your credit score. Lenders generally favour individuals with a larger share of secured loans, such as home loans, car loans, and loans against properties, compared to unsecured loans like personal loans. Hence, settling such loans can help you create the right credit mix and ultimately improve your credit score.

What Are the Cons of Personal Loan Pre-closure?

1. Prepayment Fees:

The Reserve Bank of India (RBI) has prohibited all loan providers from imposing prepayment charges on loans acquired with floating interest rates. However, loans carrying fixed interest rates are not subject to such restrictions.

Consequently, the majority of lenders apply a prepayment fee, which ranges from 2% to 5% of the remaining principal amount, for loan prepayment. Some lenders may also limit prepayment until the borrower has repaid a predetermined number of EMIs.

2. Impact on Available Funds:

Many borrowers opt to settle personal loans early by utilising their emergency funds or funds designated for essential financial objectives, mainly due to the burden of high interest rates. However, doing so can reduce your ability to manage unexpected financial crises, such as medical emergencies in the family or job loss.

Dipping into your investments set aside for critical life goals might result in taking out loans at higher interest rates in the future. Therefore, it is advisable to consider personal loan pre-closure only when you possess surplus funds beyond your emergency fund and monthly investments aimed at long-term financial objectives.

When Should You Opt for a Personal Loan Pre-closure?

Certain situations might make pre-closing a personal loan a favourable option for you:

1. During the Initial Phase of Your Loan Tenure:

If you choose to opt for a pre-closure of loan with full payment during the early stages of its term, you can achieve substantial interest savings. It is important to be aware that many lenders do not permit loan pre-closure within the first 6 to 12 months of the loan's tenure.

Even if your lender does permit, there may be a pre-closure penalty. Therefore, conducting a cost-benefit analysis is vital to assess whether a loan pre-closure is beneficial for you.

2. When You Have a Strong Credit History and Score:

If your credit history and credit score are already in good standing, pre-closing a personal loan is unlikely to have a substantial impact on your credit score. Moreover, it sends a positive signal to potential lenders that you are committed to timely debt repayment.

When Should You Not Opt for a Personal Loan Pre-closure?

1. When You Are Trying to Build Your Credit History and Improve Your Credit Score:

For individuals who are new to borrowing, adhering to the loan repayment schedule is a better option for building a credit history and improving credit scores. However, if the interest rate is too high, you may consider foreclosure of the loan.

2. When Pre-closure Penalties Exceed Savings:

Foreclosing a loan, particularly in the later stages of its tenure, may not yield significant savings, and you could also incur pre-closure charges. It is crucial to carefully evaluate the costs and benefits to determine whether pre-closing the loan aligns with your best financial interests.

To conclude:

Determining whether to pre-close a personal loan depends on several factors, necessitating a thorough evaluation of the pros and cons through a cost-benefit analysis, whether it involves making partial or complete prepayments. Hence, potential borrowers should select lenders who not only readily approve personal loans but also offer a variety of repayment choices and impose minimal pre-closure charges.

We are on Telegram! Join thousands of like-minded investors and our editors right now.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.