Is Pre-paying Your Personal Loan a Good Option?

Prepayment of loanA personal loan is quite popular in almost every country and one of the most handy financial tools both at a times of distress and celebration alike. It could be about buying that large screen television, you’ve been longing for or improving your home or for paying for your daughter’s dance lessons, or your son’s team jersey, and sometimes even to put food on the table for the family.

Being a consumption loan, you would want to square it off if you have surplus funds. However, before taking this step you must consider some key factors.

The very first thing you need to understand is – there are two options to pre-pay your personal loan. You can pay in full or make a partial payment. If you are expecting a good appraisal or bonus this time, or a lump sum from some other source, just foreclose the payment in full and enjoy the advantages of paying less interest. A personal loan generally has a lock-in of about one year after which the entire outstanding amount can be pre-paid.

For example, if the personal loan is for INR 2 lakhs at an interest rate of 15% and for a term of 5 years, the monthly EMI comes to approximately INR 4,760. At the end of the first year you would have paid about INR 29,000 towards principal and INR 28,000 towards interest. If you decide to pre-pay the full amount now, you would stand to save about INR 57,400 of interest that you would have paid over the next 4 years.

Even those who are not expecting a lump sum, but have idle money, can use the part pre-payment tool. Part payment works because it brings down the principal amount unpaid, which in turn brings down your EMIs and the total interest you pay. The bigger the amount you pay off in part, the lesser the total cost of the loan. Here are examples to explain how it works.

However, before you make a pre-payment do read the terms and conditions of your loan. Most loans come with a pre-payment or foreclosure charges – this is a form of penalty that the lender usually applies in case you close a loan before the due date. Some banks impose charges ranging from 3-5% of the outstanding amount. The rates may vary from one financial institution to another, and from loan to loan; some even do not charge anything for pre-closing a loan. Therefore, before you make a decision to partially pre-pay or fore-close a loan, you should compare the additional interest out-go to the pre-payment or foreclosure charges make a wise choice!