Personal loan bridges the gap when other financial options have been exhausted. An individual can use a personal loan to cover their immediate and unexpected expenses. And choose to prepay the loan when you have extra funds. However, there are certain penalties levied while prepaying a personal loan. Therefore, it’s recommended to read the entire list of fees and charges in detail before going ahead.
Read on to understand more about the prepayment penalty and why lenders charge for it when borrowers opt for a prepayment facility.
What is a personal loan prepayment penalty?
A prepayment penalty is a charge that lenders levy if you pay off a part of your personal loan ahead of schedule. For an instance, an individual has taken a personal loan and has been paying the EMIs for the last 12 months. Now, he has decided to pay off a part of his loan. In such a case, he’ll have to pay a certain percentage as a penalty to the lender. Usually, the prepayment penalty on a personal loan starts after a lock-in period that is decided by the lender. The part-prepayment fee varies across different lenders. Bajaj Finserv levies a fee of 4.72% (inclusive of applicable taxes) for prepayment of a personal loan.
Also, foreclosure charges will be imposed if you prepay the entire outstanding loan amount.
Benefits of Personal Loan Prepayment
Personal loan prepayment can be a strategic decision for borrowers looking to manage their debt effectively. It offers several advantages that can ease financial burdens and improve credit health. Let’s explore the key benefits:
Interest savings
One of the most significant benefits of personal loan prepayment is the potential for interest savings. Personal loans typically come with fixed interest rates, meaning that the longer the loan term, the more interest the borrower ends up paying. By prepaying the loan either in part or in full before the scheduled tenure, borrowers can reduce the overall interest outlay. This is particularly beneficial for those with a longer loan duration, as the interest compounds over time. Prepaying early cuts down the loan principal, thus reducing future interest payments.
Reduction in loan tenure
Prepayment allows borrowers to shorten their loan tenure, resulting in faster debt clearance. Rather than sticking to the original schedule, making a lump-sum prepayment or regular extra payments speeds up repayment. By doing so, individuals can become debt-free earlier than expected. This could be advantageous for future financial planning, as borrowers can reallocate funds towards savings or other investments.
Improved credit score
Prepaying a personal loan can positively impact a borrower’s credit score. Loan prepayment demonstrates financial responsibility, which is a favourable signal to lenders. As the outstanding debt decreases, the credit utilisation ratio improves, which is a critical factor in determining credit scores. Over time, this can make it easier for borrowers to qualify for other loans or credit products at more favourable terms.
Enhanced financial flexibility
By paying off a loan early, borrowers can regain financial flexibility. The regular monthly EMI (equated monthly instalment) payments can be a strain on monthly budgets. With prepayment, individuals can free up funds for other pressing needs, such as emergency savings, investment opportunities, or lifestyle improvements. This additional liquidity can offer peace of mind and a sense of financial control.
Prepayment penalty consideration
While prepayment offers substantial benefits, borrowers should be mindful of any associated penalties. Some lenders may charge a prepayment fee, which could offset the potential savings from reducing interest. It is important to calculate whether the interest savings outweigh the cost of the prepayment penalty.
In conclusion, personal loan prepayment offers benefits such as significant interest savings, reduced loan tenure, an improved credit score, and greater financial flexibility. However, borrowers must weigh these benefits against any prepayment penalties before making their decision.
Why do lenders levy prepayment charges?
A personal loan comes with a specific tenure and the lenders expect a certain interest as their profit on the loan amount. And, when an individual chooses to repay that loan beforehand, they earn a lower interest amount. To cover for the loss of income, lenders usually charge a penalty for paying a personal loan ahead of time.
Note that the prepaid loan amount goes towards paying off the principal amount only. However, with the reduced principal, a borrower qualifies for more affordable EMIs. Alternatively, if an individual wishes to reduce the interest payable, he/ she can also choose to shorten the loan tenure by keeping the EMIs intact.
Read more about personal loan interest rate before applying for the loan.
