Is personal Loan Prepayment a Good Idea or a Bad Idea?

Personal loans are the best selling financial product in present market. This product got huge popularity among the middle-class people of India because of its numerous advantages. Personal loans are unsecured loans and can be used for any purpose. Any person with a repayment capacity can take a personal loan to tide-over monetary crises of any kind such as paying medical bills, debt consolidation, bearing marriage expenses, funding a vacation and so on. Another advantage of personal loan which makes it user-friendly is the option of prepayment and part-payment.

A loan is generally taken when a person is in a temporary cash crunch. Once the purpose for which the loan is taken is successfully completed, most of them want this to get rid of the debt as soon as possible. Personal loans give the opportunity to its customers to pay it before the pre-fixed tenure. There are two ways how a prepayment of a personal loan can be done- i) Full Prepayment and ii) Part Payment

Full Prepayment

The term full pre-payment means when a person pays the total outstanding principal amount at once and become debt free. A full pre-payment saves much money for the borrower in the terms of paying interest. The total cost of loan keeps on increasing when the tenure of the loan goes longer. The prepayment of a personal loan is always sooner is better. A borrower can earn the maximum profit by prepaying the loan as soon as the lock-in period is over. A lock-in period for a personal loan is the first 12 months of the tenure. A person servicing EMIs at the first year of the tenure is not allowed to prepay the loan. Servicing the lock-in period is mandatory for all borrowers. This makes the lender to earn the minimum profit by lending. Once the lock-in period is over, one can easily opt for a full prepayment if his/ her finance allows.

Let’s understand how a prepayment makes a borrower save much with an example. Let’s say Harish has taken a personal loan of 4 lakhs for the tenure of 3 years at the interest rate of 14%.  The EMI payable every month is Rs.13,671. By the end of the tenure, the total outgo of the loan will be Rs 4,92,158  within which the total interest payable is  Rs 92,158. Here is a table which shows the repayment schedule for the entire tenure.

Year Principal Interest Percentage of Total Interest Cost Interest Saving
1 1,15,263 48,790 52.94%                           Lock-in period
2 1,32,476                  31,576 34.26% 47%
3 1,52,261 11,792 12.80% 12.80%

While analyzing the table above it is seen that more than 50% of the interest is taken by the lender during the first year of the tenure. So if a person does a prepayment soon after he is out of the lock-in period than he would save almost half of the interest payable. The same saving which can be done with a pre-pay will be decreased with the each EMI paid.

The total saving on prepayment of a personal loan also depends on one more factor which is called prepayment penalty. A prepayment penalty is charged by the lender in case of pre-closure of the loan. Different lenders have different pre-closure charges.

Here is the list of top lending institutions with their pre-closure charges

Name of the Bank Pre-closure Charges
Axis Bank    NIL
Bajaj Finserv   4% of outstanding principal along with applicable taxes
Capital First   5% of principal outstanding amount
Citibank Up to 4% on total principal outstanding  
HDFC Bank   13-24 Months – 4% of Principal Outstanding

25-36 Months – 3% of Principal Outstanding

>36 Months – 2% of Principal Outstanding

ICICI Bank 5% of principal outstanding plus applicable taxes
IndusInd Bank   Salaried: 4% of the principal outstanding after repayment of 12 EMIs. Self Employed: 4% of the principal outstanding after repayment of 6 EMIs
Kotak Mahindra Bank 5% foreclosure charges + service tax / GST on principal outstanding
Standard Chartered Bank 5% foreclosure charges + service tax / GST on principal outstanding
Tata Capital 4.5% of the principal outstanding at the time of foreclosure + ST

So while calculating the total savings by the foreclosure of the loan, one must deduct the personal loan prepayment charges.

Part-Payment

Part payment of a loan is when a borrower does a partial payment towards the loan account. A partial payment brings the outstanding principal amount down hence the interest payable gets reduced. A full repayment needs a huge amount of money at a time. If your finance doesn’t allow that then one can go for a part payment. Let take the previous example once again. After the completion of the lock-in period the borrower has already paid 1,15,263. So his outstanding principal amount is 2,87,737. So if a person pays Rs. 1,00,000  his outstanding principal amount will come down to 1,87,737.  The interest on a personal loan is built on the outstanding principal amount. So a less principal amount will make you save on interest payment.

There are again some terms and conditions of a part payment. The first condition is being out of the lock-in period. The second is the number of prepayment which can be done. Some of the lenders keep a specific number of part payments  whereas some allow it to do as many as times the borrower wants. The third condition of a part payment is the amount. Some lenders allow a particular percentage of the outstanding principal amount to be paid as part payment.

The Bottom Line

A full or part Personal Loan Payment is sure to fetch profit for the borrower but how much of profit can be earned by the deal depends on some factors. The real profit by a prepayment should be calculated by considering the given points.

1) Outstanding principal amount

2) The tenure left

3) The pre-closure charges

A prepayment of personal loan earns the maximum profit when it is done in the early period of the tenure. So while going for a prepayment one must calculate the actual profit which can be earned. If the profit is marginal that it might not be a good idea to spend one’s precious time and effort to make the prepayment happen. Whether the idea of a personal loan repayment is good or bad basically depends on the stage of your loan.

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