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Pre Closing Your Personal Loan is it a Good Idea?

17 Feb 2022 0 COMMENT

Introduction

Paying off debt on time is an excellent financial habit and works wonders for your credit. But when it comes to prepaying personal loans before its time, there are some caveats to consider. 

Typically, personal loans come with prepayment charges. And even if paying off a personal loan may not harm your credit, it could set it back a bit if you're looking to build an excellent credit history. 

Let's look at the pros and cons of pre-closing personal loans to help you make an informed decision.

Understanding full loan prepayment

Usually, a personal loan has a lock-in period of approximately six months to one year, depending on the lender, after which you are permitted to repay the entire outstanding amount. Prepaying the amount as a whole early in the personal loan tenure can allow you to enjoy the benefits of paying less interest. Besides, it can be a relief to get rid of the debt burden and save money on the interest you would have to pay.

But it could also set you back with a loss of lump sum funds when foreclosing your personal loan in full. Perhaps the lump-sum amount you have paid in full could have been better off in an investment scheme that could help accumulate wealth, especially if high penalty charges are to be paid.

Understanding part prepayment of your personal loan

When you have a lump sum quantity of extra money that is not equal to the entire principal loan amount, you can make a part prepayment on the personal loan. Doing so can reduce the unpaid principal amount, decreasing the EMI cost and the total interest.

But it can help to know that only if you put down a considerable amount of money as part prepayment will it help in reducing the EMI amount every month. An interesting aspect of a part prepayment on a personal loan is that you can do it more than once until you prepay the entire amount. Doing so can help reduce your EMI and total interest amount to be paid.

Additional read: How to manage financial stress effectively

When to pre-close an ongoing personal loan

Specific scenarios when pre-closing a personal loan can be an ideal choice. These include:

· Early in the tenure.

You can save a considerable amount on the interest if you decide to foreclose your personal loan with a complete prepayment early in the loan tenure. Remember to look into your loan contract agreement on foreclosure penalties and the lock-in period to prepay loans. Also, it can help to conduct a cost-benefit analysis in determining whether pre-closing a personal loan is a good idea.

· With an excellent credit rating and history.

If you hold a high credit score, pre-closing a personal loan may not impact your credit score significantly. Besides, it could also indicate to other lending institutions your commitment to repay debts before time.

When not to pre-close and ongoing personal loan

· To build your credit score.

If this is your first personal loan, repaying it per the schedule can be a better option as it can help build your credit rating and history.

· Exorbitant prepayment penalty charges.

Pre-closing a personal loan in the latter stages of the loan tenure may not benefit you with considerable savings. Besides, you may also have to pay the penalty charges as laid down in the loan contract. Once again, work out the cost-benefit analysis to understand if you need to make a pre-closing decision.

When considering to pay down debt on your personal loan, remember to review and understand the terms and conditions in your personal loan agreement to decide on the financial decision best for you.

Additional read: How to create wealth to achieve your goals

Conclusion

Deciding to pay off your personal loans early will come down to your situation and how doing so could affect your budget and financial plan. If you're worried about an impact on your credit score, it can be a good idea to understand where you stand regarding your credit rating and your credit history by downloading your credit score and report. Decide on the pre-closing of the personal loan based on your individual situation and budget.

Disclaimer

ICICI Securities Ltd.( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470.  Please note, loans related services are not Exchange traded products and I-Sec is acting as a distributor to solicit these products. All disputes with respect to the distribution activity, wou ld not have access to Exchange investor redressal forum or Arbitration mechanism. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.