Pros and Cons of Opting for Personal Loan Prepayments

The high interest costs and EMI burden associated with a personal loan often leads many borrowers to consider prepaying or foreclosing their existing personal loans. While prepayment of personal loan is a beneficial proposition for borrowers in most cases, they should still undertake a detailed cost-benefit analysis before making personal loan prepayment to ensure a sensible decision-making process.

Benefits of Personal Loan Prepayment

Some of the benefits of prepaying your personal loans are as follows:

Savings on Interest Cost

Personal loan prepayment helps borrowers to save on the interest costs that they would have incurred had the loan continued for the entire term. For example, if a loan applicant wants a personal loan of Rs. 10 lakh at 13% p.a. interest rate for a 5-year loan tenure, the EMI will be Rs. 22,753 and the total interest cost will be about Rs 3.65 lakhs. If they decide to repay the entire outstanding loan amount after 1 year, they will be able to save around Rs. 2.44 lakhs in interest costs.

Many personal loan borrowers incorrectly assume that they can make interest cost savings only if they prepay their loan in the early stages of the loan tenure. However, they can also make savings on EMI payments if they make the prepayment of their personal loans in  later years. They should use an online personal loan prepayment calculator to find out the total interest savings on making prepayment/foreclosure. However, the borrowers should also consider the personal loan prepayment fees and other additional costs (if any) to ascertain the net savings on exercising the prepayment option.

Apply for Personal Loan at Attractive Interest Rates Apply Now

Increase EMI affordability for the borrowers

Banks/NBFCs prefer lending to loan applicants whose total EMIs, including existing EMIs as well the EMI for the new loans, are within 50% to 60% of their total monthly income. Thus, those exceeding this limit have lower chances of availing loans. Such personal loan borrowers can improve their loan eligibility by prepaying their existing personal loan and thereby, reducing their EMI/NMI ratio within the bracket of 50% – 60% of their monthly income.

Lowers the proportion of Unsecured Loans in the Credit Mix

Credit mix is the ratio between the total outstanding secured and unsecured loans or other credit facilities. Credit bureaus factor in this ratio while calculating the credit scores of individuals. Bureaus tend to assign higher credit scores to borrowers having a greater share of secured loans in their loan portfolio.

As personal loans are unsecured in nature, their prepayment will reduce the proportion of unsecured loans in the credit mix. Thus, an increased share of secured loans can improve the credit score of a borrower and thereby, increase their chances of availing another loan.

Disadvantages of Personal Loan Prepayment

Some of the main drawbacks of personal loan prepayment are as follows:

Prepayment Charges

RBI has barred all lenders from charging any fees on prepayment of personal loans availed at floating interest rates. However, there is no such restriction for borrowers availing personal loans at fixed interest rates. Most lenders charge a prepayment penalty of up to 5% of the outstanding principal amount of personal loans. Many lenders also restrict borrowers from making part-prepayments and/or foreclosure of personal loans until the repayment of a predetermined number of EMIs.

Apply for Personal Loan at Attractive Interest Rates Apply Now

Personal Loan Prepayment and Foreclosure Charges Table

Charges as of 29th October 2024

Apply for Personal Loan at Attractive Interest Rates Apply Now

Negative impact on Liquidity

Many borrowers exhaust their liquidity or existing investments to prepay their personal loans. However, doing so may adversely affect their capability to deal with any financial emergency arising out of events like loss of income, medical issues or other contingencies. Tapping into existing investments allotted for achieving important financial goals can force borrowers to avail loans at a higher interest rate for meeting those unavoidable financial goals. To avoid this situation, existing personal loan borrowers should opt for prepayment only if they have adequate emergency funds. They should also avoid using their existing investment meant for unavoidable financial goals.

Conclusion

Prepayment of personal loan is an attractive proposition for existing borrowers as it allows them to reduce both their interest costs and overall repayment burden. However, the incurring of prepayment charges, if charged by the lender, and the reduction in liquidity can become a deterrent. Borrowers having restricted liquidity can reduce their repayment burden and interest cost by transferring their personal loan to lenders offering lower personal loan interest rates.

Apply for Personal Loan at Attractive Interest Rates Apply Now