The need for credit can arise anytime. No matter how prepared you are, a crisis situation may throw your routine life out of gear. While you can plan and avail loans like Home Loan, Vehicle Loan or an Education Loan, there are many circumstances for which there are no provisions of getting a secured or a pre-planned loan.

These may be anything from a wedding of a close family member, medical emergencies, buying some gadgets or durables for your home, a vacation or down payment for your home loan or just about anything.

Personal Loan is an effective way of getting past this need for immediate credit. It works because personal loans are not tied with a particular end use or need extensive documentation and are disbursed in a short period of time.

Personal Loans and High Rate of Interest

While this loan comes with its own set of benefits, the interest charged on a personal loan is on the higher end as it is an unsecured loan and a short-term loan. The percentage of interest charged can range between 11-20% depending upon numerous other factors like the amount applied for, income status of the individual, and credit score.

For Ex: For a personal loan of Rs 4,00,000 availed at an interest of 15% for a term of 5 years, the interest to be repaid at the end of the term comes up to Rs 170958 which is almost 43% of the original loan amount.

Considering this, it takes a huge strain on your finances, making you want to get down with the loan at the earliest. What are the options available on hand when you want to get down with the loan at the earliest?

Additional Reading: How Pre-closure of Personal Loan Can Impact Your Credit Score?

As your credit coach, we have solutions to make your journey through credit as smooth as possible. There are options for prepaying the entire loan amount or even a part of the loan amount that can help you lower the burden of your personal loan as soon as possible.

When Can You Prepay Your Personal Loan?

All lenders, i.e. banks and NBFCs who lend personal loans to their customers have certain terms and conditions that varies with lenders. Generally, personal loan carries a lock-in period during which you are not allowed to prepay or part pay your loan. This lock-in period generally ranges from 6-12 months.

As personal loans are given based on fixed rate, the prepayment incurs a penalty which could range between 3% to 5% of the loan amount depending on the lender.

Benefits of Prepayment

As understood from our calculation above, there is a lot of amount involved in payment of interest. Early closure of your personal loan allows you to save a lot of money that goes on interest and monthly EMI. It will offer a breathing space to plan out your future finance and savings.

For example: Going with the abovementioned example, if you have availed a loan of Rs 4 Lakhs for a tenure of 5 years at 15% interest rate, you will be paying an amount of Rs 1,70,958 as interest alone.

After a period of 1 yr which is considered as the lock-in period, now you must have paid off Rs 1.14 Lakhs with interest. Your outstanding loan amount to be paid with interest will be Rs 4.56 Lakhs with principal amount standing at approximately Rs 3.41 Lakhs.

If you are looking to pre-pay this amount, the lender charges a prepay penalty. Some banks may have different penalties based on the remaining tenure.

For Ex: HDFC Bank Personal Loan has the following pre-payment penalty charges

  • 4% of the outstanding principal amount for completed tenure of 13 -24 months  

  • 5% of the outstanding principal amount for completed tenure of 25 -36 months

  • 2% for more than 36 months of completed tenure

For illustration let us work with a penalty amount of 5%. So, you would need to pay back your principal of Rs 3.41 Lakhs with a penalty of 5%. Let us look at the savings possible with repayment of this amount.

A table makes all this easier, as always.

 

 Original Loan Amount 

 Rs 4,00,000 

 Interest to be Paid 

 Rs 1,70,958 

 EMI 

 Rs 9,516 

 Outstanding principal amount after 1 year 

 Rs 3,41,923 

 Outstanding Interest (On original terms) 

 Rs 1,14,844 

 Penalty (5%) 

 Rs 17096 

 Savings after prepayment 

 Rs 97,748 

You can see that there is a huge amount of savings involved in prepaying the loan just after the completion of the term of 1 yr. This benefit reduces as the tenure of the loan reduces. However, there is always some benefit involved in prepaying a personal loan, unless it is at the very fag end of the tenure where paying the penalty does not make economic sense.

Because at the very end of the tenure, you would have repaid most of the interest and it is the principal which remains and will need to be repaid anyways.

Additional Reading: All you need to know about Personal loan part payment and pre-closure

Prepayment and Credit Score

Foreclosure of your personal loan will have a positive impact on your credit rating. Though it may not reflect immediately on your credit report, the credit score will soar once it is updated. With a good credit score, you can get better terms on future loan applications.

In addition, as you would have cleared off your loan commitment, it should also have an impact on your EMI to income ratio, thereby making you eligible for bigger loans in future. This would be a plus point if you are looking to apply for big ticket loans like home loans, etc.

End Note

While trying to pay off your debts, make sure that you do the calculation when prepaying your personal loan. Read the terms and conditions of your loan agreement carefully and talk to your lender if you are in any doubt of what you are liable to pay. The remaining loan tenure and penalty fee are the factors that you need to consider before making a final decision.