With the advent of technology, it is easy for anyone to get a loan from anywhere now. A personal loan is one such type of loan that is a savior for many people due to its ability to meet your long and short-term needs by submitting minimal documentation and no need for collateral. It is processed quickly provided the borrower fulfills all the criteria including the HDFC CIBIL score or any other credit score from the credit agency depending on your lender and offers great flexibility of usage.
However, you must know that personal loans, a type of unsecured loan, have the highest interest rates. Being unsecured in nature means they fetch a minimum premium ranging between 15 and over 20 percent per annum. Hence, it makes complete sense if you are thinking about prepaying your personal loan and closing the account. Under personal loans, borrowers get the option to prepay and foreclose their accounts. This option is usually exercised if the borrower’s income increases or they get some unexpected cash. Before you proceed with the foreclosing of your account, it is wise to weigh your options. Continue to read further to get an insight into this option.
Let’s talk about the pros first.
Lower Interest Outgo: The main benefit of paying off a personal loan early is avoiding the interest costs that would otherwise be incurred if the loan were to be repaid over its whole term. As we stated before that personal loans due to being unsecured in nature have substantially higher interest rates that increase the borrower’s interest outgo. If borrowers have the required resources, it is advised that they pay off their loan which will not only help them save money but in the long run, helps to improve their HDFC CIBIL score.
Reduces the burden of debt also: By prepaying your loan amount, not only will your HDFC CIBIL score will improve but it also reduces your overall debt load. This has the effect of easing the mental strain associated with having to pay the EMI each month.
Impacts your Credit Score: Although the prepayment of your personal loan ultimately closes the loan account, it does not have an immediate impact on your credit score whenever you will do SBI CIBIL score check in the future. In the long run, it helps to strengthen your credit rating over time.
Improve the affordability of EMI for borrowers: Banks and NBFCs prefer to lend to applicants for personal loans whose combined EMIs, including those for previous loans and the new EMI, are less than 50% to 60% of their entire monthly income. Customers who exceed this limit consequently have a lower chance of being approved for a personal loan. These borrowers can increase their loan eligibility by prepaying an existing personal loan and thus, bringing their EMI/NMI ratio within 50%–60% of their monthly income. Some lenders also provide personal loans with no prepayment fees.
Reduces the share of Unsecured Loans in the Credit Mix: The ratio of total outstanding secured and unsecured loans or other credit facilities is known as the credit mix. Credit bureaus give higher credit scores to borrowers who have a diverse range of credit in their loan portfolio.
Since personal loans are unsecured, early repayment will lower the percentage of unsecured loans in the credit mix. It may thereby improve borrowers’ credit scores which you can check via SBI CIBIL score check and improve your prospects of obtaining additional credit.
Cons of prepaying the personal loan
Prepayment Penalty Fees: Lenders aren’t permitted by the RBI to impose prepayment penalties on personal loans with adjustable interest rates. On the other hand, this limitation does not apply to borrowers who take out Personal Loans with fixed interest rates. Prepayment fees on personal loans that might reach 5% of the total principal balance are rather common. Interest savings may be reduced when prepaying a personal loan with a fixed rate. On Personal Loans, many lenders additionally forbid partial payments or foreclosure fees until they have received many installments.
Charges for foreclosure: Almost all loans are associated with a variety of extra fees and charges that a borrower has to pay. Prepayment fees or foreclosure fees are one of these you should know beforehand. The amount of prospective interest income that the lender could have received is decreased when a borrower repays the loan amount before the end of the initial loan tenure. Therefore, if the borrower makes a partial or full prepayment, the lender will impose a penalty or fee. This cost will generally be higher if one prepays too quickly and reduces as one approaches the end of the loan tenor.
Need to make large payments: Despite its benefits, prepaying a personal loan has a significant cost because you must make lump-sum payments to pay off the balance, which will temporarily reduce your financial freedom.
Affecting Liquidity Negatively: Many borrowers use all of their available cash or current investments to pay back their loans in a hurry to improve their score whenever they do SBI CIBIL score check in the future. But doing so can compromise their capacity to handle any monetary emergency brought on by things like lost income, medical issues, or other unforeseen circumstances. If they use present investments for that purpose, borrowers might have to take out loans at a higher interest rate to achieve unavoidable financial goals. Customers with outstanding personal loans should only select the prepayment option only if they have enough cash set aside for emergencies. Additionally, they ought to avoid using current investments as leverage for unavoidable financial goals.
To prepay or not to prepay-
One should borrow as little as possible and pay it back as quickly as feasible, according to an old proverb that holds particularly true with personal loans due to their exorbitant interest rates. When compared to loans secured by collateral, such as a car loan or a home, personal loans might have a more negative influence on the HDFC CIBIL score if it isn’t paid on time. Prepayment not only reduces your debt load but has a positive influence on your credit score if you can pay off the loan quickly when you do SBI Cibil score check. Therefore, before you decide to prepay your loan or foreclose on a property, carefully evaluate these factors as well as the prepayment penalties, additional interest, etc.
Conclusion
A personal loan is a practical way to handle urgent financial requirements. However, it comes with a hefty interest rate if your CIBIL score wasn’t good at the time of submitting an application. Thus, it is advisable that if the borrower has additional resources, they should prepay the personal loan. When deciding whether you should prepay the loan or wait for the tenure to get over, you must consider the benefits and cons of each option. One should choose prepayment if the loan agreement has no prepayment clause or, even if it does, the amount is minimal. Prepayment of a personal loan typically has more benefits than drawbacks.
