Does foreclosing a personal loan really save your money? Let’s find out!
Imagine receiving an increment or realizing that you can save money on interest by paying off your personal loan quicker. It is best to see both sides of the coin before going all in. So, let us take a look at this from a broad perspective.
Here is a list of pros and cons of foreclosing a personal loan to help you make an informed decision:
Pros of paying your personal loan early:
- Better Savings
The biggest advantage of paying your personal loan sooner is that it may lead to savings. Typically, if your loan agreement is one with terms that allow you to make full or part-prepayments without any charges, then you might end up saving a lot on the interest.
Suppose you have taken a personal loan of INR 2,00,000 /- at 15% interest rate for a term of five years, you would have to pay a total of INR 85,479 in the form interest. However, if you pay the EMI of INR 4,758/- for the first year and then decide to make a full prepayment of the remaining amount, you could end up saving INR 67,175 minus the ‘prepayment charges plus GST’ on interest. (The exact savings amount will vary as per the penalty fee and terms).
The same goes for partial prepayments. It works because it lowers the principal amount to be repaid, which in turn lowers the amount of EMI and the total interest to be levied. Moreover, most borrowers think if they have already paid substantial number of EMIs then it does not make sense to close the loan account early. However, since banks calculate the interest on the basis of remaining principal amount, you may still be able to reap the benefits of lowered payable interest.
- More Disposable Income
Once you have paid off your loan, you could have more money available as disposable income. You can use this better availability of funds towards savings, shopping, investment plans and other financial goals.
- Morale Boost
Foreclosing a personal loan relieves you from the stress of accumulating and managing EMIs on time, every time. Not only does it give you a sense of relief, but also helps you feel more financially in control, thereby improving your psychological health and general attitude towards life.
Cons of paying your personal loan early
- Prepayment Penalty
Being an unsecured loan, personal loan usually carries a pre-payment fee. While some banks charge a flat fee, others charge an additional interest typically ranging from 3 to 5% and the penalty can be calculated by taking the remaining interest due into account. It is advisable to calculate the penalty fee beforehand and check whether it will lead to savings or an increment in the overall cost that you incur for the remainder of your loan tenure.
- Budget Constraints
Your disposable income could be affected during the return period as a substantial corpus of the available cash might go towards prepayment. So, you will have to put all other plans, which require adequate finance on hold.
- Lock-in Period
Another aspect to look for is the clause that’s related to the lock-in period in your agreement as it may not allow you to pay off your loan early. The lock-in period for most banks is typically one year. It is only after this lock-in period has passed that you can consider making additional payments to foreclose your personal loan. Anything before that is simply a waste of time and effort.
Prepaying a personal loan can also have a positive impact on your credit score as it deems you a responsible borrower. Make sure to weigh all the factors including the remaining loan term tenure, prepayment penalty and interest rate before moving in a particular direction.
