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What is Loan Pre-Payment and How it works?

Credit allows us to fulfill our needs that our savings or income cannot support. Also, there are different types of loans, depending upon the needs of the borrower. Each loan is tailored differently to serve a particular purpose. However, when it comes to personal loans, one cannot deny the fact that a higher rate of interest is charged for it as compared to other loans.

Individuals who are in debt often look for ways to either consolidate or reduce the debt. And prepayment of loans is one such popular method to repay the debt prior to the full tenure of the debt. Apart from reducing the debt, it also will increase the amount of savings for you. Nowadays, several banks offer this facility to make the task of reducing debt easier.

Therefore, now you can cut the interest from personal loans by prepaying before the end of the tenure. You wouldn’t have to bear the burden of high-interest rates for longer. Clear your debt at one shot by prepaying your debt. If you have no idea of how all this works, go through this article to know the ins and outs.

What is loan prepayment?

When a borrower lends a loan, he/she has to repay it within the end of tenure in EMIs or Equated Monthly Instalments. However, if he/she has a big chunk of money available, they can repay it either in full or in part before the end of the tenure. The repayment of the loan before the actual tenure is known as loan prepayment. Apart from releasing you from the debt, it also cuts interest and saves you a lot of money.

What should you keep in mind?

Though the prepayment of loans is highly beneficial, there are certain things all borrowers need to know.

  • Prepayment penalty: Some banks have the lock-in period, and if someone intends to pay back during this period, he/she will be charged with a penalty. This is particularly applicable for business loans or non-floating rate loans.
  • Prepayment during the lock-in period: Several banks have a lock-in period of 1 to 3 years. And during this period, a borrower won’t be able to prepay. However, the RBI guidelines say that there’s no lock-in period for floating-rate loans.
  • Interest rate: Mostly, banks calculate the interest of the loan using the method of reducing balance. This signifies that the rate of interest is usually higher at the beginning, but eventually, it reduces over time. Therefore, a prepayment calculator can be used to find out exactly how much you are going to save by opting for the pre-payment plan.

Advantages of prepayment of Personal Loan

If there’s any loan that carries the highest rate of interest, it is personal loan. Though they are very beneficial for you in many ways, the rate of interest might become a financial burden in the long run. And this might lead to delinquency and default. So, if you have got a significant amount of money available, you should prepay it and avoid any future financial burden.

Along with that, you also save a good deal of money on interests. Let’s take an example. You’ve borrowed Rs. 2 lakhs at 14% interest for 5 years. A 1-year lock-in period exists for personal loans, and 5% penalty for prepayment is charged on it.

However, if one prepays immediately after the end of the lock-in period, it is hugely beneficial and saves you a lot of money. Though the interest rates reduce towards the end of the tenure, one would still be a benefit if he/she prepays.

How does it affect the credit store?

Every credit action of your affects the credit store in one way or another. Now you must be wondering how the prepayment of the loan will affect the credit store, right? Well, the prepayment doesn’t affect the credit store immediately. However, after a certain period, it will showcase a positive effect on the credit score. Also, when you repay the personal loan, the image of the credit portfolio will be enhanced as you’ll be reducing the number of unsecured loans.

Apart from that, you’ll also be freeing yourself from EMI payments, which will make you eligible for further future credits, when needed. When you have got a good record, banks will be willing to provide you with loans during hard times in the future.

CONCLUSION

Prepayment of loans is highly beneficial if you want to avoid paying high-interest rates. Also, this option depends upon a lot of factors such as loan tenure, prepayment penalty, kind of loan, interest rate, and more. Not to forget that different banks have different guidelines when it comes to prepayment of loans. So, when you’re taking a loan from a bank, make sure you properly go through the agreement before signing it.

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