5 Things to Know About Personal Loan Prepayment

Personal Loan Prepayment is a process of repaying the loan before its tenure is over. This can be done when an individual with an outstanding personal loan has sufficient funds to repay the loan partially or in entirety. This helps the borrower get rid of their debt early and save money by avoiding having to pay a significant amount of interest. Prepayment can be done as a part-payment or in a lump sum depending on the bank’s policy and the borrower’s capacity. A cautionary note must be added here – banks charge a penalty of 3-5% of the remaining principal amount. Prepaying a loan means that banks miss out on the profit earned in the form of interest. However, prepayments can help you save money in spite of these charges. Here are a few things that must be kept in mind for personal loan prepayment. 1. Prepayment Charges: Most banks charge a penalty of 3-5% for prepayment of the loan. These charges are levied to partially compensate the bank for the loss that they make by missing out on the interest that the borrower would have paid. However, in some cases, there may actually be no prepayment charge at all. In order to protect consumers, the Reserve Bank of India has directed banks not to charge any penalty on prepayment of loans but this rule applies only to loans with floating interest rates. In this spirit, some public and private sector banks do not charge any fee for prepayment of loans with fixed interest rates either. 2. Part Payment: Part payment is a viable option if the terms of the loan allow you to do so. It can be considered when an individual only has enough funds to repay a part of the outstanding loan amount. Usually, part payments also carry some prepayment charge. Yet, it still works in favour of the borrower because such it brings down the burden of payment by reducing the EMI amount and the interest payable on the remaining loan principal. However, it is important to remember that this method works only when an individual has a sufficiently large sum of money at their disposal. Part payments below a minimum amount are not entertained by most banks. Even if banks allow smaller amounts, the savings are offset, or in most cases, surpassed by the prepayment charges. Partial payment has another significant advantage in that it can be done multiple times. For instance, part payments can be made annually until the loan has been paid in full. 3. Read the Offer Document Carefully: Banks follow strict guidelines for personal loan prepayment and part-payment. All of them will be listed in the offer document which you must read carefully. Do all the necessary research before you even apply for the personal loan, especially if you are planning to make prepayments in the future. With some banks, you have to pay a fixed number of EMI’s before prepayment becomes an option. In such cases, prepayment is usually allowed after 3-12 EMIs are paid. If the bank does not allow prepayments at all, you can look into other options like transferring your loan. In light of these factors, proper financial consultation is recommended before opting for personal loan prepayment. 4. Boosts to Credit Rating: Repayment of outstanding debt like loans boosts your credit rating. This Impact is cumulative. What this means is that making prepayments will help you improve your credit history in the same way regular EMI payments would. However, since prepayments allow you to pay off your outstanding debt early, your credit portfolio will potentially improve faster. 5. Early Prepayments are the Best: The primary goal of making prepayments is to save on having to pay large amounts of interest which can easily become a financial burden. It is important to keep in mind that early in the tenure, the amount of interest is higher than it is towards the end of the loan duration. To make the most of this, prepayments made early on are the most beneficial. For a five-year loan, you pay about a third of the total interest in the first year. This is the main reason why banks allow prepayments only after a minimum number of EMIs have been paid. However, early prepayments are not always feasible for the borrower. But even if prepayments are made later on or in parts, the borrowers gain a significant advantage. They also get rid of outstanding debt early. This means that you would not only save money but also attain a peace of mind that only comes from being debt-free.