Is opting for personal loan prepayment a good idea?

Is opting for personal loan prepayment a good idea?

When strapped for cash, to mitigate your financial commitments availing of a personal loan is a suitable solution. Routing for this solution keeps you anchored in times of cash crunches or financial mismatches. Just like a companion or pal in disguise, a personal loan helps you to manage your unanticipated requirements without disturbing your cash flow and budget. Additionally, benefits like flexibility, unsecured, multipurpose make personal loan the best solution for rainy days.

Loan prepayment is when you choose to repay your entire loan even before you complete your loan repayment tenure. On occasions when you have surplus funds, you might select to pay off your excess loan in advance in place of waiting until the tenure ends. Prepaying your personal loan implies the acquisition of substantial savings in terms of interest that you otherwise would have paid. However, the vital question here is – Is prepaying your personal loan a good decision? While prepaying might bring great peace of mind to you, it might not be a financially beneficial option.  

Are you confused about when you should prepay your loan? We are here to reveal this to you.

Consider personal loan interest rates.

Usually, distinct loans have a distinct rate of interest attached. If you hold multiple credit options, prepaying the one having the highest rate of interest is sure to make a huge difference. Usually, personal loan interest rates are the highest of other secured loan options.  

Is the debt monster lurking around corners giving some sleepless nights to you? If you hold multiple debts, which you must clear, the simplest way to get out of this is to repay the debt at the highest rate as soon as possible. This process is known as an avalanche measure of debt repayment.

Set up a retirement fund

The initial thing you must do is to weigh to see if the fund that you have today will lower the sum that will be with you for future use. Saving up for your retirement days is an extremely necessary step in your financial planning. When you save for your old age needs, the earlier you begin, the better it is. Beginning earlier permits you to save over a longer time period.

Setting up retirement back up while at the same time repaying your loans is a practice in defeat. Instead, it is better if you emerge out of it to become debt-free. After your loan is fully repaid, you can set aside the money and even boost your financial portfolio.

In case you are factoring in to pay off your personal loan so that you can begin with your retirement savings journey, go ahead with it.

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What must you keep in mind before you prepay your personal loan?

The rate of interest you are expected to repay in the procedure of repaying your loan is a way for your bank to earn some profit. Personal loan EMIs are determined in a way wherein the bank continues receiving the rate of interest throughout the loan repayment tenure. So, in the case you decide to prepay your personal loan, the interest that the bank would otherwise earn would fall. Thus, banks charge a prepayment penalty to compensate for the potential income loss. Before you repay your personal loan, ensure to review if your lending institution charges a penalty for the loan prepayment. Compute the penalty charge and compare the same with the savings that you would otherwise earn.

The next crucial point you must keep in your mind is the lock-in period. Generally, for most loans, there is a minimum lock-in period during which you cannot repay the loan amount. Evaluate the terms in your personal loan agreement and compute the amount you will pay as a foreclosure charge and the amount you will end up saving in case you repay your loan throughout your repayment tenure. If you are keen on repaying your debts faster, prepaying your personal loan would be a commendable option. However, note that it may not always be one of the most financially sound decisions. Thus, a calculation is important before you proceed ahead. Ensure that you do your mathematics well before. Also, it will be wise on your part if you thoroughly read all the terms and conditions of the loan agreement before you approach the lender with your prepayment decision.

Checkpoints to factor in before prepayment decision

Assume you applied for a personal loan a year back. And because of your good credit profile and stable salary, your personal loan eligibility is high. As an outcome, the lender agrees to provide you with the loan. However, since the time you availed of the personal loan, the rate of interest has moved down. Lower rates equate to lower loan EMI. Without any loan friction, you will move to a lower rate of interest right away, i.e., make new loans at the low-interest rate and use the personal loan proceeds to close the high-cost existing loans. Well, banks do not like this, at least those that provide you with loans. Thus, there is an expense to discourage you from personal loan prepayment. The regulations permit NBFCS or banks to charge a prepayment penalty if you prepay a fixed-rate loan.

Usually, personal loans are fixed-rate loans. Based on the loan terms, this prepayment expense can be up to 4 to 5 percent of the outstanding loan proceeds. Thus, before you route for a personal loan prepayment option through the balance transfer route, ensure to check these 4 variables before.

       Cost of closing the existing loan (foreclosure or prepayment fees)

       Upfront expense of availing of a new loan (prepayment charges and other ancillary fees)

       Loan repayment tenure (assume that it is the same for new as well as the old loan)

       Difference between the rate of interest on the new and old loans

It is thoroughly fair to assume the rate of interest of your new loan should be considerably lower than your new loan interest rate. Otherwise, this exercise of opting for prepayment may be meaningless.

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