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What is Loan Prepayment?
Loan prepayment is the process of repaying the loan before the loan’s due date. Loan prepayment has its own benefits. Also, let us understand how the interest is calculated for EMIs if you prepay a loan.
Benefits of Loan Prepayment
- You can go debt-free faster:
- It means reduced interest outflow
- Partial prepayments can lower your debts
- It improves your credit score
How Is The Interest Computed For EMIs If I Prepay A Loan?
If you decide to repay a loan at any point in time, the bank computes the interest from the last EMI day to the prepayment date. Then, this interest is deducted from the prepaid amount. The remaining amount is credited towards the principle. Suppose, you have taken a loan for 7 years payable every 4th of the month and you decide to repay the entire loan in the 60th month on the 25th, then the interest on the outstanding principal will be calculated for 21 days (25-4). It will then be added to the repayment amount. There is no excess interest to be repaid, as the interest rate is calculated on a monthly basis.
Also Read: Prepayment Penalty: What Happens If You Pay Off Your Loan Early?
Prepayment Fees Charged By Banks
The borrowing price of a bank is lower than the lending price. The bank earns the difference in the borrowing and lending price by lending the money, and it can do so through the entire tenure of the loan. If the customer chooses prepayment, the rate of interest that the bank would usually earn over the extra period decreases. Some banks charge prepayment fees to make up for the loss in income. The prepayment fees charged vary considerably among banks.