An old adage says don't borrow more than you can repay. In other words, one should borrow as little as possible and repay as quickly as possible. This holds particularly true for personal loans and credit cards, as they come with some of the highest interest rates in the market. If you can prepay or part pay a loan, it is best to go for it without further ado.
Personal loans attract some of the highest rates of interest (barring interest charges on the unpaid amount on your credit card). Often ranging between 10 per cent to well over 20 per cent, personal loans command such high interest rates primarily because they are often unsecured in nature. Despite the high interest rates, personal loans are popular in the country (second, perhaps, to gold loan) as it is processed quickly. This helps get over a temporary or urgent need of cash. You can use a personal loan to consolidate your credit card debts, buy consumer durables, plan a wedding, get medical treatment or even go on vacation—there is no restriction on the end-use. This coupled with the easy availability makes personal loans one of the most sought-after credit products in India. Personal loans and other such similar loans are offered by most banks across the country with some variations in charges and fees.
Are you thinking to prepay your loan entirely? Are you wondering whether it might be a smart move? Read on to know more!
What happens if you pay off your loan Early?
A personal loan (amongst other loans) generally has a lock-in period of about one year after which the entire outstanding amount can be prepaid. If you are thinking to prepay your loan entirely, it is best done relatively early into the tenure of the loan. The trick is to prepay the entire amount early in the tenure of the loan—when you prepay a loan early, you tend to save a lot on the interest. However, if you find you are not able to save for a full prepayment early on, do not fret. You can choose to make a full prepayment even at a later stage in the tenure. It is always better to prepay the loan and get the monkey off your back.
Do keep in mind that there are prepayment fines if you decide to prepay your personal loan. Many banks have penalty rates ranging anywhere from 2 to 5 percent of the outstanding amount. RBI (Reserve Bank of India) has mandated banks to stop charging customers when prepaying a loan account—however, this only applies to loans taken on a 'floating rate' basis. Since most personal loan products are on a fixed rate basis, the rule does not apply.
Prepayment penalties are generally based on your outstanding amount (remaining loan balance). The longer you have had your loan and the less you owe and the smaller your prepayment penalty will be.
Additional Reading: Prepayment VS Foreclosure Of Loans
What is a loan prepayment penalty?
The concept may sound strange to those who are struggling to get out of debt. Some may ask—why pay to get out of debt early? Well, simply put, a prepayment penalty is a fee that you must pay if you decide to pay off a loan before the loan tenure is over. That's right, as strange as it may sound, you need to pay a fine for paying off a loan sooner rather than later.
Why do lenders charge prepayment fees?
Some loans are designed to last a certain number of years (such as mortgages which have a tenure of at least 25 years, or car loans which have a tenure of at least 5 years). If you decide to pay the loan off early, you may have to pay a penalty if a penalty was part of your loan agreement. Always read the fine print on a loan agreement before you sign.
If you are trying to get out of a loan with a prepayment penalty, run some numbers. Figure out how much the penalty will cost compared to your savings. Be sure to consider the total interest cost, and not just your monthly payment. Consider using online calculators to calculate how your loan stacks up.
Part Payment and Its Benefits
Part-payment of a loan happens when you have a lump sum amount of idle money with you, which is not equivalent to the entire principal outstanding loan amount. Part-payment works by bringing down the outstanding amount unpaid, which in turn brings down your EMIs and the total interest you pay. However, keep in mind that part payment only works when you make a significant amount of lump sum money as part payment.
Part-payment of your loan is often an easy and effective way to save down on your interest amount. What happens when you part pay your loan? The part payment amount gets deducted from your principal outstanding as on date/month of making the partial payment. If you are wondering about the effect it has on your credit score, well, worry not. Part-payment of a loan generally has no effect on your credit rating barring the fact that it reduces your total loan burden. This should help you to pay off the loan completely in the stated loan tenure.
Full Prepayment and Its Effect on your Credit Score
Full prepayment or even part prepayment of an ongoing personal loan does not have an immediate effect on your credit score. However, in the long run, a full prepayment effectively is successfully closing a loan account, which does cause your credit score to go up.
Shop around for the best deals
If you are looking for loans with less or no prepayment penalty, shop around for the best deal. Even a 1 percent deduction on the fine rate will bring down your prepayment burden substantially. Different lenders will approach your needs differently. With some lenders, you may have to pay a higher interest rate, which means your monthly payments will be higher, but at least you will be able to get out of the loan at any time. If you are shopping for loans, you have come to the right place. You can have a look at our website and see which loan product best suits your needs.