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Is Opting for Pre-Closure of a Personal Loan Right Option
Posted on Thursday, March 28th, 2024 | By IndusInd Bank
People generally apply for a personal loan when they need funds for unplanned expenses. They consider closing a loan whenever they have the required funds to avoid paying interest.
As these loans are unsecured and given keeping in mind the current income and CIBIL score of the borrower, the rate of interest is usually higher than other secured loans. To foreclose a loan means closing a loan before the loan tenure ends. There are both pros and cons to early loan closing in the case of a personal loan. Let us see what they are.
Why Consider Pre-Closing a Personal Loan?
Pre-closing a personal loan reduces your debt burden as these are expensive loans. It helps increase your eligibility if you decide to apply for any other loan in the future as your Debt-to-Income Ratio (DTI Ratio) improves. A lower loan outstanding leads to a better DTI ratio.
However, there are also cons associated with pre-closing a personal loan that you must know before going ahead with the application for closing your loan account.
A personal loan is a collateral-free loan, and can be availed by both salaried and self employed. However, if you are self-employed and are using this facility, you should think twice before closing the same. This is because banks prefer to offer these loans to salaried individuals since they have steady risk-free incomes.
Also Read: What are the Eligibility Criteria for a Personal Loan for Self-Employed Individuals
Reasons for Not Foreclosing a Personal Loan
There are several reasons for not foreclosing your Personal Loan. Let us discuss them:
1. Foreclosure in the later stages is expensive:
When you look at the amortisation schedule given to you after the disbursement of the loan, you will see that the interest component is usually front-loaded in your EMIs. What that means is that your earlier EMIs go more towards payment of the interest and the later EMIs go towards payment of your principal amount. In such a scenario, if you are going for a foreclosure later in the loan tenure, you are mostly paying for the principal amount in one go as the majority of the interest has already been recovered. Why would you unnecessarily take a chunk out of your savings or your liquid funds to repay something at one go that you can over, let’s say, 12 months? You could rather invest that money to earn interest and continue to pay your EMIs.
2. Penalty Charges:
When you borrow from a bank or lender, they earn income through the interest you pay over a set period, known as loan tenure. If you decide to pre-close your loan, the bank loses out on their income. You will have to pay prepayment penalties of up to 5 per cent of your principal outstanding, even in an online personal loan! Such penalties do add up to a significant amount. Why would you want to bear an outflow of your funds in such a manner? Do remember that all types of personal Loans do carry these clauses.
Conclusion
A personal loan comes with interest that a borrower needs to pay. On top of it, closing the same before the tenure comes with pre-payment charges and is often not recommended. You need to take a good look at your finances and understand the financial implications before submitting your application for closing a loan account.
Disclaimer: The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. Hence, you are advised to consult your financial advisor before making any financial decision. IndusInd Bank Limited (IBL) does not influence the views of the author in any way. IBL and the author shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any financial decisions based on the contents and information.
