Personal loan is one of the most demanded financial products due to its flexibility. You can use a personal loan for many reasons – a medical emergency, consolidating debt or travelling. Apart from personal loan interest rates, you must be aware of personal loan pre-payment charges.
What is Pre-Payment?
It is a payment that you make towards the loan repayment before it reaches maturity. There are two ways you can make a personal loan pre-payment – pay off the complete loan all at once or in parts. Banks allow you to make pre-payments, but they charge a penalty for it.
Types of Pre-Payment
If you are interested in paying off the full loan amount before time, it would be wiser to do it in the earlier stages. Keep in mind that most banks have a lock-in period of one year. This means you can only pay off the outstanding amount after one year.
If you cannot pay the debt in full, you can opt for part pre-payment. The amount you pay will get deducted directly from the total outstanding principal amount. Because the interest is charged on the outstanding amount, you can make decent savings when the principal comes down.
When Should You Choose to Pre-Pay the Loan?
Pre-payment is a good idea when:
- You have a large sum of money and the capacity to settle the amount without affecting your budget
- You can save on the interest rate charged in case of a longer tenure. When you make an early repayment, it could reduce the EMI or the tenure.
3 Advantages of Pre-Paying your Personal Loan
Reduction in Loan Tenure and EMI Amount
If you have a personal loan of 5 lakhs with a tenure of 5 years, you can pre-pay the loan if you have extra money. Doing this will reduce your monthly EMI amount and tenure duration. Generally, personal loans have a lock period, but you can pay in full once the lock period is over. Use the lock period to save enough money to pre-pay the loan in full.
No Pre-Payment Charges
If your loan tenure is short, then personal loan prepayment won’t be a good idea. You might end up paying too much towards the pre-closure charges. But, if you are into a floating rate of interest, then there will be no pre-payment charges at all.
Talk to your lender and understand the charges associated with pre-payment. Evaluate how much money you will save in the end. The terms and conditions differ from one lender to another, so ensure you consider all that.
Improvement in Credit Score
Your credit score is directly linked to your outstanding debt. If you pre-close a loan, it will reflect on your credit score. Pre-payment is considered a smart way to increase the credit score. It equals to successful payment of the outstanding loan and closing debt.
Make sure you do some number crunching to determine if prepayment of personal loan would be beneficial for you or not. Analyse all the information and make an informed decision.
Author Bio: Shiv Nanda is a financial analyst who currently lives in Bangalore (refusing to acknowledge the name change) and works with MoneyTap. Shiv is a true finance geek, and his friends love that. They always rely on him for advice on their investment choices, budgeting skills, personal financial matters and when they want to get a loan. He has made it his life’s mission to help and educate people on various financial topics, so email him your questions at firstname.lastname@example.org.