As humans, we have various needs and wants. Availability of credit is a great bonus that helps you in achieving those needs or wants much beyond what your income or savings can support. Moreover, comparable to varied needs is the availability of various types of credit, each one tailored to cater to a purpose. A home loan to buy a home, an education loan for pursuing higher education, a business loan to expand and grow a business; you name it, you have it.
But what if you have a want that is beyond the scope of these loans that have fixed end use terms? Yes, of course, you have a loan for that as well in the way of a personal loan. These loans are very convenient to avail and come without any end-use condition. Further, personal loans are disbursed quicker and involve no collateral. All of it making a win-win situation for a borrower.
However, on the flipside, as personal loans present a higher degree of risk to a lender, the rate of interest charged on these loans turn out to be much higher than loans like Home or Auto loans. You must be aware that higher rate of interest means a higher EMI burden on the borrower, which often leaves the borrower wishing he/she could clear off the loan at the earliest.
The rate of interest charged on a personal loan can range between 11-25% p.a. Considering a term of 5 years on a loan of Rs 2,00,000 availed at a rate of interest of 14% sees a borrower repay an amount of Rs 2,79,220 in total. So the amount of interest paid on the loan is Rs 79,220 which is quite high and can set finances out of order.
Additional Reading: Learn more about Personal Loan EMIs
One of the easiest ways to close a loan is to Prepay or Part Pay on the loan.
In this article of ours, we would discuss the advantages and the proper procedure that you would need to follow if you decide to close your personal loan.
What is Prepayment or Part Payment of a Loan?
Normally, once a loan is availed, it is paid back in Equated Monthly Instalments (EMIs) till the end of the tenure of the loan. However, if you have a bigger chunk of amount available at your disposal, you have an option to either to repay a part of the principal or repay the entire amount of principal in one shot and close the loan.
Can I Prepay Or Part Pay A Personal Loan At Any Point In Time During The Tenure Of The Loan?
While some loans like floating rate home loans have been allowed by the RBI to be prepaid or part paid at any time during the tenure of the loan without any penalty, the same treatment is not available to personal loans as they are fixed rate based loans.
Most of the personal loans issued by banks or NBFCs have different lock-in periods as prescribed by the lenders. They can range anywhere between 6 months to 1 year or more. This is one of the important details that anyone going in for a personal loan has to pay attention to.
A lock-in period means a period during which you cannot prepay or part pay any loan.
However, off late more and more lenders are allowing personal loans without any lock-in period.
After The Lock-In Period, Does Prepayment Or Part Payment of Personal Loan Incur Any Penalty?
As mentioned above, personal loans are fixed rate based loans and hence, carry a penalty on prepayment or part payment of the loan. The penalty rate can vary among banks and the remaining tenure of the loan.
For Example, ICICI Bank charges 5% per annum of principal outstanding plus GST as Prepayment charges
HDFC Bank Personal Loan has the following prepayment penalty charges
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4% of the outstanding principal amount for completed tenure of 13 -24 months
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5% of the outstanding principal amount for completed tenure of 25 -36 months
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2% for more than 36 months of completed tenure
What are the Advantages of Prepaying a Personal Loan?
Personal loans carry the highest rates of interest, only next to the interest charged on an outstanding credit card balance. We agree that a personal loan can help you in more than one way. However, higher interest rates often turn into a financial burden leading to increased chances of default and delinquency.
Not to mention about the potential savings on interest that you can achieve by prepaying your loan.
Let us take you through an example to illustrate the savings you could achieve by prepaying a loan. We continue with our earlier example of a personal loan of Rs 2,00,000 availed at an interest of 14% for a period of 5 years. Prepayment penalty of 5% is chargeable and a lock-in period of 1 year exists.
| Pre-Payment made after 1 year |
Pre-payment made after 3 years |
|
| Original Loan Amount | Rs 2,00,000 | Rs 2,00,000 |
| Interest to be Paid during the original tenure of the loan | Rs 79,219 | Rs 79,219 |
| EMI p.m | Rs 4,654 | Rs 4,654 |
| Outstanding principal | Rs 1,70,298 | Rs 96,925 |
| Outstanding Interest (On original terms) | Rs 53,077 | Rs 14,763 |
| Penalty (5%) | Rs 8,515 | Rs 4,846 |
| Savings after prepayment | Rs 44,562 | Rs 9,917 |
If the prepayment is made immediately after the lock-in period, we see that there is huge savings in terms of interest payable. However, this benefit goes on reducing as the tenure reduces as EMIs are structured in such a way that interest payments are higher during the initial tenure of the loan. However, it may still be beneficial to prepay and avoid paying higher interest rates.
So it is worthwhile to do a detailed cost-benefit analysis before deciding to prepay a personal loan.
What Are The Advantages of A Part Prepayment of A Personal Loan?
You must have often heard that experts advise you to make as many part payments as possible to lower the interest burden on a home loan. So, going by the same logic and the working given above, part payments on a personal loan should also bring in similar benefits. However, unfortunately, part payments are not allowed on a personal loan by many lenders.
It may be good to check with your lender if they would allow part payment on a personal loan.
What Effect does a Prepayment have on Your Credit Score?
All credit actions have some bearing on your credit score. So you must be curious to know the effect that a prepayment has on your credit score. A prepayment does not have an immediate effect on your credit score. However, it will go on to show that you have successfully closed your loan which will have a positive effect on your credit score in due course.
Also by prepaying a personal loan, you will bring down the proportion of unsecured loans in your credit portfolio which will also act as a positive development for your credit score.
To add to the benefits already mentioned, you would free up some portion of your income from the EMI payments, thereby making yourself eligible for future credit, if needed.
Additional Reading: How Pre-closure of Personal Loan Can Impact Your Credit Score?
End Note
Prepayment and Part payment (if allowed by the lender) have huge benefits to a borrower. Therefore, it makes it very important to ensure to go in for a personal loan that has favorable payment conditions.
FAQs:
- What are the average prepayment charges when I prepay a personal loan?
Prepayment charges depend on the total tenure you have completed on your loan. You might have to shell out higher prepayment charges when less tenure has been completed and lesser charges when lesser tenure is remaining. The average prepayment charges range between 2-5% of the total amount outstanding.
- Is it really beneficial to make part payments to your personal loan?
Yes, definitely. When you make part payments against your personal loan, the total outstanding is reduced and hence your interest amount will also reduce.
- Does prepaying a loan improve my credit score?
Prepayment may not have much effect on your credit score. However, if you prepay and close the loan on time, it will have a positive effect on your credit score.
- Can I prepay my personal loan any time during the loan tenure?
Personal loans have a condition that you can make prepayments only after completing 12 EMI payments.
- Will part prepayments reduce my EMI amount?
If you choose to make part prepayments, you can talk to the bank and request them to reduce the EMI amount or reduce the total tenure.