Personal loan prepayment: Should you close early? Experts explain financial impact and potential savings
Paying off a personal loan before its scheduled term can reduce the interest burden and free up monthly cash flow. However, prepaying a personal loan may not always be the best financial move.
Borrowers juggling personal loans must weigh the interest and overall cost savings they will achieve against foreclosure costs, and also consider how their emergency funds will be affected once the personal loan is repaid before its scheduled tenure ends.
What is personal loan prepayment?
Personal loan prepayment means repaying all or some of the outstanding loan before the original repayment tenure ends. The borrower, i.e., the holder of the personal loan, can either make a partial prepayment to reduce the outstanding principal or foreclose the loan by paying the entire amount due.
While completing this task, future interest costs can be reduced, and lenders may charge prepayment or foreclosure fees, depending on the terms of the loan agreement.
When does personal loan prepayment make sense?
The decision should begin with a few simple questions that are specific to each borrower. For example, how much interest will you actually save by closing the loan early, and what will it cost you to do so? What are the pros and cons of closing out a personal loan in your specific case?
Mukesh Pandey, Founder & MD, Rupyaapaisa.com, says, “There are many advantages to prepaying your personal loan. It pays to consider if the cost of closing the loan early is lower than the overall savings that will come from it. Be careful, however – keep in mind that before prepaying, you must check whether you have enough money saved in case of emergencies, and whether there are other expenses coming up that will put a strain on your finances.”
Borrowers should compare the remaining interest payable with any foreclosure charges and the return they could earn by keeping the money invested or in savings.
What was personal loan used for?
Vibhore Goyal, Founder & CEO of OneBanc Technologies, says borrowers should first consider how the personal loan was used. “Personal loans were designed for emergencies. They now fund lifestyle,” he said, highlighting the growing use of unsecured borrowing for consumption.
Goyal adds that lifestyle spending financed through personal loans can be costly as interest rates are generally high, and such borrowing does not offer the tax deduction available on other loans, such as a home loan interest. He also cautioned against using personal loans to fund equity investments. Such borrowing effectively creates leverage, thus increasing the financial risk if investments fall.
Is personal loan prepayment draining your emergency fund?
Having adequate savings is crucial before making a large prepayment. Goyal says, “Borrowers should ensure they have at least six months of emergency cover before using any surplus funds to repay a loan.”
Borrowers should also check the loan agreement for foreclosure or part-prepayment charges. RBI rules on such charges can vary depending on the type and terms of the loan, so the applicable conditions should be confirmed with the lender.
What should borrowers do?
Personal loan prepayment can make financial sense only when the interest saved is significantly higher than the associated costs and the borrower has sufficient emergency savings.
The decision, however, should not be driven simply by the desire to become debt-free. Before prepaying, compare the interest saved, foreclosure charges, remaining tenure and emergency corpus.
There is no single rule that works for everyone regarding personal loan prepayments; the prudent choice is to reduce debt without weakening your overall financial position.
