Early Loan Repayment - Should You Consider It?

A personal loan can fulfil a temporary or an urgent need for cash. A personal loan taken from a bank or NBFC or funds used from an instant credit card can be used to buy consumer durables, get medical treatments, go on a vacation, and lots more.

Life is full of ups and downs, and there could be a situation wherein you can pay off a sizeable chunk of the loan or maybe the entire amount. However, you must understand the consequences of repaying a personal loan fully or partially and the pros and cons attached to it.

How can you repay your loan early?

It is simple economics; if you have idle cash which gives you less return on investment when compared to the interest of your loan, it is wiser to pay off the personal loan.

There are different ways of repaying your loan:

1. Full Prepayment:

You can save a lot of interest if you prepay for a loan in full much earlier into the tenure of the loan.

2. Part Payment:

Part-payment means the principal amount is partially paid, which brings the EMI, total pending Principal amount, and the interest charged down. This can be done regularly or occasionally. However, you should keep a tab on the prepayment charges before making partial payments.

Is there a prepayment penalty?

A prepayment penalty is a monetary burden that you may have to bear if you are repaying your loan off earlier.

• Some banks can charge penalty rates ranging from 3-5 % when a customer decides to repay a loan.
• The Reserve Bank of India had recently instructed financial institutions to stop charging this penalty, but it is only applicable on loans that are on a 'floating rate' basis. But as most of the personal loans are on a fixed rate, this rule does not apply.
• But some do not charge a penalty which becomes a great advantage for prepaying a loan.
• You must go through the terms and conditions of your loan agreement to ascertain the penalty of prepayment – whether it will be applicable or not. You should read the fine print when applying for the loan.

How to calculate the amount of penalty?

You can use the loan calculator to assess the prepayment penalty. The simple formula is to add the total interest for the remaining tenure plus any ongoing fees. If you prepay the whole amount, you can save this final value.

Further, you can subtract the prepayment and other charges from the total amount. The remainder is what you will save, and a negative figure would mean more cost than savings.

Pros and cons of early repayment

Prepayment gives both psychological benefits and measurable financial benefits. Let us look at the benefits of early loan repayment.

Early Loan repayment comes with many perks. Lenders calculate the percentage of your income that is used to pay off that debt, which is known as the debt-to-income ratio. If you repay the loan early, your debt-to-income ratio increases, which means you get eligible for approvals for loans in the future with better terms.

1. Boost Your Credit Score

If you pay your loan earlier than agreed upon, it means you can clear your debts faster. You tend to be a responsible borrower, thus enhancing your borrowing capacity, which can be helpful if you need to borrow more in the future.

2. Peace of Mind

The sooner you finish your debt, the sooner you will be in a better financial position. Eliminating your debt gives you peace of mind and reduces stress.

3. Save Money

You save on EMIs and interest charges by repaying your debt beforehand. In the case of an online credit card debt, it’s better to repay as quickly as possible. Repaying personal loans can improve your financial health.

4. Other Benefits

Less interest translates to more money saved. You can further use the money you saved to hit new financial milestones, you can invest this money or you can even splurge on a vacation etc. The ongoing fees can be avoided, and it leads to an opportunity to get a new loan that might offer a better rate.

Cons:

1. Interest on business loans is deductible, and you may lose this deduction.
2. You could lose a significant amount through prepayment charges.
3. It leaves less money in your pocket for other things, which means you enjoy fewer luxuries in your monthly budget.
4. You could lose out on investments in retirement, a new home, or education expenses.
5. If the loan is pre-computed, then you won’t save by repaying as the costs are already included in the loan.

The Bottom-line

Early loan repayment is not on everyone’s radar, but being able to clear your debt early can give you peace of mind. After repaying a personal loan early, you may be ready to move on but take the decision very carefully to avoid a wrong financial turn. Consider talking to an expert if you have queries.

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