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 personal loan prepayment is a beneficial proposition for borrowers in most cases, they should still undertake a detailed cost-benefit analysis before making a personal loan prepayment to ensure a sensible decision-making process.
Benefits of Personal Loan Prepayment
Some of the benefits of Personal Loan prepayment 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 prepay their personal loans in the 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.
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 loan. Many lenders also restrict personal loan borrowers from making part-prepayments and/or foreclosure until the repayment of a predetermined number of EMIs.
DISCLAIMER -- THIS VIDEO ONLY FOR EDUCATION PURPOSE........
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