Why Pre-Closing of Personal Loan is Crucial?

Pre-closure of a Personal Loan is paying back the total borrowed amount before the tenure of the loan gets completed. It can reduce your financial burden and save you on interest payable, but depending on the agreement, there may be fees or penalties. If you're considering pre-closing your Personal Loan, it's good to know the pros and cons of this option before taking any action.
 

What Is Personal Loan Pre-Closure?
 

Pre-closure of a Personal Loan is paying back the total borrowed amount before the tenure of the loan gets completed. It can reduce your financial burden and save you on interest payable, but depending on the agreement, there may be fees or penalties. If you're considering pre-closing your Personal Loan, it's good to know the pros and cons of this option before taking any action.

The pre-closure of a loan is basically paying the full amount of the loan before the official loan repayment tenure. It is usually done in one instalment. Pre-closing a Personal Loan, to put it simply, will help you save a lot of money on the interest you will pay, and there is a fixed amount of money freed from your disposable income that was being used to pay EMIs. A pre-closure is very different from a regular loan closure where you make the scheduled EMIs over the repayment period of the loan.

What are the Different Types of Personal Loan Closures?

To decide if is it good to pre-close a personal loan or not, you must first know about the different types of loan closure options. 

1. Personal loan part-payment 

Personal loan part-payment refers to a scenario where you pay the lump sum amount towards the debt repayment. The lump sum paid here is only the portion of the outstanding principal amount and not the total amount owed. The scenario is ideal when you have extra cash, and to make the most use of it, you opt for part-payment to reduce your outstanding debts and monthly obligations. Let's look at an example to better understand how it affects you.
 
Assume you took  personal loan of Rs 3,00,000 from XYZ lender with a 5 years repayment period. The interest rate applicable on your instant loan is 15%. In the sixth month of your loan tenure, you intend to make a partial payment of Rs 50,000. The implication of the preceding situation will be as follows:
 

As you can see from the example above, pre-payment not only lowers your EMI but also saves you a significant amount on interest payments. However, bear in mind that for part-payment, you need to pay a certain amount towards a part-payment fee. The part-payment fee percentage is agreed upon at the time of signing the loan agreement.

Now that you are aware of the various closure options, it's time to understand when the pre-closure is an ideal option for you.

    2. Closure Regurlar:

Under this type of closure, the borrowers pay their EMI regularly until the end of the repayment tenure specified in the loan agreement. Here, the lender does not impose any additional fee or penalty. The Personal Loan closing procedure remains the same as it is mentioned in the loan agreement. 

Under this type of closure, the borrowers pay their EMI regularly until the end of the repayment tenure specified in the loan agreement. Here, the lender does not impose any additional fee or penalty. The Personal Loan closing procedure remains the same as it is mentioned in the loan agreement. 

    3. Pre-closure:

If you have received some additional funds or have received an increment in your salary, you may want to save a significant amount of money on interest by closing a Personal Loan early. Before you do so, keep in mind that most financial institutions have a lock-in period for Personal Loan foreclosures and they charge an additional cost for closing a loan. However, under the RBI's new directive policy, financial institutions are not allowed to charge pre-closure penalties on floating loans. 

Also Read: Closing Your Loan Account?  Do These Things First
 

     4. Bad loan closure: 

Under this, if the borrower fails to make interest and principal payments over an extended period of time, the financial institution will write off the loan. Such a closure has legal ramifications and the borrower may face charges under the IPC section or be forced to file for bankruptcy.

Why is Pre-Closure of a Personal Loan a Good Option?

• Saving On The Interest Amount

One of the biggest advantages of pre-closure of a personal loan is that it gives you the ability to save a lot on the interest amount. It helps in reducing your financial burden and additional outflow of funds through interest. Hence, if you have enough liquidity to part with, it makes sense to close your loan before the end of the tenure.

• Reduction Of Debt

Living with debt is not easy. You always have to take your EMI into account before making any other financial commitment. Plus, if you need another loan, the existing debt might impact your chances of getting it. However, bear in mind, that existing debt will not impact your credit score. Regular repayment of EMI will make all the difference in positively affecting your credit score.

• When You Have A Lump Sum Amount For Disposal

It is beneficial to consider pre-closure if and only if you have a lump sum amount available at your disposal. Do not be in a hurry to pre-close your loan and do consider other financial commitments as well. Ensure that you have enough funds for emergencies.

Also Read: Foreclosing A Loan Keep These Points in Mind

• If You Are Early In Your Loan Tenure

You can enjoy savings predominantly if you are early in the tenure of your loan. If a considerable time has passed and you have already paid the larger chunk of your loan, then you have already borne most of the expenses. However, most lenders have a lock-in period of 12 months before which they do not allow pre-closure of the loan.

• If Savings Outweigh The Pre-Closure Charges

Calculate the savings in the interest amount and compare it with the pre-closure charges. Use a personal loan pre-closure calculator to arrive at the right figure. Make a cost-benefit analysis and consider pre-closure only if it leads to significant savings.

What are Pre-Closure Charges for Personal Loans?

(Lenders generally apply pre closure charges when a borrower pays off a personal loan before the end of their loan term. This is because lenders rely on the interest charged over the life of the loan, and early repayment means that they will miss out on the rest of the interest amount. The pre closure charges for personal loan may vary depending on time of early repayment, and the outstanding loan amount.)

Also Read: How Personal Loans Help During An Emergency

When is Pre-Closure of a Personal Loan Not a Good Option?

As mentioned earlier, do not forget to compare the savings against the pre-closure charges for personal loan. Before opting for it, chart out your financial goals for the next few years, consider any upcoming increase in your savings, and account for medical emergencies and other contingencies.  After locking up funds for other commitments, check if the available amount is worth foreclosure.

How to Use a Personal Loan Preclosure Calculator

(There are some general directions you can follow when using a personal loan pre-closure calculator:

• Gather the necessary information about your personal loan, such as the outstanding loan amount, the interest rate, and the remaining loan term.
• Next, enter the required information into the loan closure calculator.
• If your lender charges a pre-closure fee, enter that amount as well.

Once you have entered all the necessary information, the calculator will show an estimate of the foreclosure charges that you may be required to pay if you choose to close your personal loan before the binding date.)

How to Close Personal Loan Early?

If you are wondering how to pre-close personal loan, don’t stress much, simply visit the nearest branch of your lender and discuss your requirement to pre-close the loan with an officer there. Seek advice on the fees for foreclosing and other processing charges. Compare it with your savings on interest. And, if you are satisfied and wish to go ahead, submit the required documents and ask for your lender’s personal loan closure letter format.

Can I Repay The Personal Loan Earlier?

If you want to close your loan before its binding due date, you just have to follow a few basic steps. 

• Inform Lender: 

Pay a visit to the lender from where you have obtained a Personal Loan. Inform them that you would like to close your Personal Loan, and seek information regarding the fees and penalties that come with a Personal Loan foreclosure.

• Submit Documents: 

Carry all the relevant documents including the account passbook that reflects the EMI debit from your account. You must provide a photocopy of all essential documents to the lender, along with a letter requesting a loan closure. If you are not sure how to write a loan closure letter, look online for a loan closure letter format or a sample letter for closing a loan account.

• Acknowledgement Slip/NOC Certificate: 

Once you have settled all your outstanding dues, the lending institution will issue you an NOC. The NOC or acknowledgement slip will include all the loan clearance information. Maintain a proper record of your NOC for future use.

Documents Required for Closing Personal Loans? 

• Letter requesting a loan closure along with a loan closure form. You may also opt for a Personal Loan closure online. 
• Identity and address proof such as PAN Card, Aadhaar Card, Passport, Voter ID etc. 
• A bank statement that displays the instalments paid to date. 
• Cheque or demand draft for settling outstanding loan balance.

Will my lender halt me from closing a Personal Loan before the binding due date?

Every lending institution has its own set of rules and regulations. Most lenders would not let you foreclose on a loan before a year of availing of it. They also look for 12 months of uninterrupted EMI payments. Apart from that, there are certain charges levied when closing a Personal Loan before the agreed repayment tenure.

Impact of Personal Loan Closure on a Credit Score

Personal loan foreclosure has a positive impact on borrowers' credit scores. Pre-closure does not have an immediate effect, but it can be beneficial in the long run. It reflects that you have successfully repaid the dues, and because of your high earning potential, the loan is closed well ahead of time. 
 
Partial prepayment of a personal loan, on the other hand, does not have much effect on your credit score. 

Also Read: Closing Your Loan Account?  Do These Things First 

Conclusion

Consider when you want to pre-close your loan over why should you do it. The timing makes all the difference when it comes to closing your loan. Weigh the pros and cons while making projections about your income. Of course, repayment of your loan will pave the way to being debt-free and help you make new financial commitments without the stress of repayment of an existing loan.

FAQs

1. How do you write a loan closure letter?
In a pre-closure letter to your lender, you should introduce yourself and request pre-closure of your personal loan, acknowledging any pre-closure charges. Ask your lender to provide you with the total pre-closure amount and a statement of account, and confirm your commitment to paying the pre-closure amount.

2. Is NOC required for personal loan?
An NOC (No Objection Certificate) might be required in a personal loan when you have fully repaid the loan amount. When you close your loan account with the lender, the NOC serves as a confirmation that there are no outstanding dues.

3. What happens to CIBIL score after loan closure?
If you have a good credit score, foreclosing a personal loan may not have a big impact on your credit score. And it does show potential lenders that you are committed to repaying your debts on time.

4. Does foreclosure reduce interest?
Making a foreclosure payment on your personal loan can reduce your interest outgo. When you prepay or foreclose a loan. By making an early payment you are effectively reducing the principal amount of the loan, which means that you will pay less interest. This is because the interest is calculated on the outstanding principal amount, and reducing the principal amount reduces the interest charged on the loan.
5. What are foreclosure charges on a personal loan?
Foreclosure charges on a personal loan are fees levied by lenders when the borrower repays the entire loan early. Charges vary by lender and are usually a percentage of the outstanding loan amount.