Personal loans are a widely known way to get money, whether for a wedding, a trip, a festival, or a new gadget. They are reliable, flexible, easy to get and don’t need any security. Even though getting the loan is simple, it is expensive.
Due to the high EMIs and interest rates, many people with personal loans consider paying them off early or getting rid of them. You should conduct a cost-benefit analysis before personal loan prepayment to make sure you are picking the right choice.
This article discusses the pros and cons of loan prepayment.
What is prepayment?
When you make a loan prepayment, you repay all or part of your loan before its due date. According to the prepayment clause, the lender will charge a fee equal to a proportion of the total loan amount, or foreclosure fees on a personal loan, if you repay your loan before the set term. Personal loan prepayment fees vary from one lender to another.
What are two types of prepayments?
There are three types of prepayments.
1. Full prepayment
Personal loans usually have a one-year lock-in period. After that, you can repay the entire balance and save on interest. Even if you pay early, you will still have to pay interest. The rates can vary from 3% to 5%. You might be surprised that some public and private lenders do not charge foreclosure fees on personal loans. If you need cash right away, you can get it without paying too much interest rates.
2. Partial prepayment
You can make a partial prepayment if you have a large sum. A partial prepayment will make a dent in your loan payments. It can lower the principal amount you owe, lowering your monthly payments and interest.
What are the pros of a personal loan prepayment?
Paying off your debt before the tenure ends is a good way to ease financial stress. Let’s look at the pros and cons of prepayment.
You save money on interest.
When you repay a personal loan, you save capital income costs that you would’ve had to pay if you had kept the loan open for the whole tenure. Many people who take out a personal loan think the only way to save funds is to pay off the loan early. You can also save money by having to look for a personal loan with no prepayment fees.
If you pay off your debts faster, you can save money on your EMI payments. You can use a loan prepayment calculator to determine how much interest you will save by paying off the loan early. You should, however, figure out prepayment fees and other extra costs (if any) when calculating how much you will save overall by choosing the prepayment option.
It will make EMIs more affordable for you.
Banks and NBFCs are more likely to give personal loans to people whose total EMIs, including those for existing and new loans, are less than 50% to 60% of their total income. So, if your EMI is more than 60% of your income, you have a lower chance of receiving a personal loan.
You can improve your loan eligibility by paying off an existing personal loan and lowering your EMI/NMI ratio to between 50% and 60% of your monthly income. Some lenders also offer personal loans that can be paid off early without fees.
It reduces the number of loans in the mix of credit.
Since personal loans are unsecured, early payment will lower the percentage of unsecured debt in the credit mix. As a result, a greater proportion of secured loans may improve your credit scores, enhancing your chances of obtaining additional loans. To be on the safe side, you can take advantage of a personal loan with a no-fee prepayment option.
What are the cons of loan prepayment?
You have to pay penalty fees for prepayment.
The RBI has told all lenders that they can’t charge fees for paying off personal loans with variable interest rates early. On the other hand, borrowers who get personal loans with a fixed interest rate need to pay prepayment charges.
When you repay a personal loan, you may have to pay a prepayment penalty of up to 5% of the remaining principal amount. If you repay a personal loan with a fixed rate early, you might save less on interest. Many lenders will only let you make partial payments or prepayments on personal loans once you’ve made a few payments.
It will affect your liquidity.
For paying back the loan, you can use up all of the cash or investments you already have. But if you do that, you might not be able to manage a monetary emergency like a medical problem. In such a case, you may have to take out a loan with a higher interest rate if current investments are used beforehand.
You must only choose the prepayment option if you have enough funds for an emergency. You should not use your existing investments to reach unavoidable financial goals.
So, before you choose to foreclose or repay your loan early, you should think about these factors and carefully consider the prepayment penalties, extra interest, or whether or not it might help you.
Personal loan prepayment is appealing to many because it will help them reduce their interest costs and total repayment load. But many lenders charge fees for repaying the loan early, which reduces your cash flow. It can be a drawback. On the other hand, you can easily repay your loans and save money on interest by refinancing them with a lender who has lesser interest rates.
For more details, you can visit Piramal Finance and explore the personal loan options.