Understanding Pre-closure Charges Applied on Personal Loans

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While being in a debt may not seem to be ‘too good a situation’, however, taking a loan is necessary and eases the financial stress, many times. For instance, if you take a personal loan, you can deal with any kind of expenses, be it a pending bill, home renovation expenses, funds for an important purchase, wedding expense, education fee, sponsor travel, pay for a medical emergency and just about everything. Isn’t that a great relief? If you are cash-strapped then personal loans are best on rescue.

What is a Personal Loan Pre-closure?

Each bank and NBFC has a set of different norms and rules regarding the loan scheme, and pre-closure charges are one of the crucial factors to consider. So what is a pre-closure? It is basically closing the loan before its tenure ends. For example, you have taken a personal loan for a period of 3 years, but are able to arrange the outstanding loan payment amount, after a year. You can then pre-close the loan after a year by paying the full amount in complete, than paying EMIs through 3 years.

Now, the benefit of doing this is that you get rid of the debt before time and eliminate the burden of paying EMI regularly and keeping a track of it. The cons may come with pre-closure charges. Not every bank charges a pre-closure fee after a point of time. But, if you are closing the loan too early, the financial institution may charge a percentage of amounts on the outstanding loan amount, as a fee. Fully settling a loan will include payment of borrowed amount and the charged interest at the time of loan closure.

Why Do Banks Charge a Prepayment Fee?

Financial institutions levy a pre-closure charge in order to recuperate some interest as they will be losing a customer. Ending the loan before its tenure will cause a revenue loss for the banks and NBFCs as well, thus a minimal charge is taken as the pre-closure fee in some cases, especially if the customer has paid less than 6 EMIs. To find out the tenure after which the banks and NBFCs may charge this fee, you will have to check out relevant conditions of each of these institutions.

Prepayment charges may vary between 2 per cent and 5 per cent depending on the type of personal loan taken, and the terms and conditions of the loan. As personal loans entail larger rates than many secured loans, the banks lose a large amount of interest, in cases where you plan to close the loan early. Thus the charges for pre-closing loan will also differ depending on the interest rate decided for the loan.

Is it Wise to Pre-close a Personal Loan?

A personal loan can be repaid partly of fully before its closing date. A part payment may or may not apply additional charges, but a full prepayment may. The benefit of the latter is that it does away with the worry of paying regularly. Part payment can be done only twice in the entire loan period. But the frequency of part payment may differ from a bank to another.

It is important to note that only payment of the principal amount, in this case, will really give any benefit, because the financial institutions usually recover the interest payment in the initial stages of EMIs.

How to Plan Prepayment or Pre-closure of Loans?

You must first try and understand if closing the loan early will really bring any benefit. If it saves you money than what you would have to pay in entire loan tenure, then definitely it is feasible. The charges associated must be considered when calculating these probabilities. When taking a personal loan, if you already have in mind that you will repay sooner, then checking the pre-closure charges is vital. Because the total loan cost will not just depend on the interest rate charges, but other fees and charges as well.

If you are able to arrange an amount, you have several options. Put it for investment, use it for other purposes and expenses, or close a personal loan earlier than its tenure. You have to now think, which the best option for you is. For instance, if investing the amount reaps you higher returns than what you would pay for the loan, then pre-closure must not be chosen. Similarly, if you have other unavoidable expenses, then the fund must be used for it, than you taking a new loan for this expense.

How to Approach Prepayment/Foreclosure of Personal Loans?

It is easy to understand why the facility of pre-closure is provided by banks and NBFCs. Choosing this route to close the loan, is a choice that you have to make after weighing the options, as stated above. It is always better to get out of debt, but at the same time, you have to judge your financial circumstance to take this decision. Never forget to check the pre-closure charges before applying and finalizing a personal loan scheme, because these charges are counted in the total cost of the loan.

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