What is Loan Repayment? & Types of Loan Repayment Methods

When you avail of a loan, you agree to repay the principal and the interest over the entire duration. These are divided into equal installments that are repaid over the loan tenure.

If you do not pay the loan installment on time, you may have to pay additional fees along with the unpaid amount.

Moreover, any delays in paying the installments may indicate poor financial skills and management and may lead to severe consequences.

To avoid falling into a debt trap, it is important to understand loan repayment and how it works.

What Is Loan Repayment?

It refers to the act of paying back the borrowed amount to the lenders along with the applicable interest. The amount is repaid as per a pre-determined schedule as equated monthly installments (EMIs).

The EMI comprises principal and interest and must be repaid within the loan duration.

How Does Loan Repayment Work?

The commonest way in which repayment works is through EMIs. In this method, the monthly installment is fixed at the start of the loan and comprises principal and interest.

The EMI is paid on a particular date during the month until the end of the loan duration and the borrowed amount is repaid in full.

However, the EMI does not equally comprise principal and interest amounts. During the initial loan duration, a larger component of the EMI is paid towards interest.

As you continue paying the installments, the interest comprised within the EMI reduces and a higher amount is used towards repaying the principal amount.

Different Types of Loan Repayment Methods

Based on the type of loan and the lenders, the following three options are available for repaying the borrowed amount.

EMIs

This is the commonest option and requires paying a fixed installment on a particular date of the month. The EMI comprises payment towards principal and interest.

Some lenders may allow you to prepay the loan amount after paying a certain number of installments. However, the lender may charge a certain prepayment penalty.

Prepayment can be done in the following two ways:

• Partial prepayment: Here you repay a part of the outstanding loan balance, which reduces the principal amount and helps decrease the interest outflow over the balance loan tenure.
• Full prepayment: This is when you repay the entire loan amount that is outstanding, which is also known as pre-closure.

Bullet payment

Some financial institutions allow you to make a bullet payment to repay the borrowed amount.

During the loan duration, you pay only the interest and at the end of the term, you repay the entire principal amount in a single bullet payment.

Step-up payment

Under this method, the installment at the start of the loan tenure is lower. It gradually increases over the loan duration after considering your income growth.

This allows you to repay the borrowed amount without any financial difficulties or liquidity crunch.

Understanding amortization table

The loan repayment calculation is outlined in an amortization table. The lenders will share the schedule with you at the start of the loan.

The table shows you the amount you will pay as the monthly installment. Additionally, it shows the portion from the EMI that is allotted towards principal and interest payments.

The amortization table provides the following information:

• Loan details, such as amount, tenure, and rate of interest
• The frequency at which the installment is payable; it is generally monthly
• Total installment amount that is payable
• The amount of the installment that is allocated towards repaying the principal, which gradually increases over the loan duration
• The monthly interest that is payable, which gradually decreases over the loan tenure
• Balance loan amount, which is calculated by deducting the principal amount from the current outstanding amount

If you make any extra payments, the amount is automatically adjusted in the amortization table.

The extra amount is used towards the principal repayment and future interest is recalculated on the reduced loan amount.

What Is Loan Repayment Schedule & Why Is It Important?

This schedule shows you the exact details of the entire facility, which includes the borrowed amount, interest rate, tenure, and installment.

It is an important document because of the following.

• It helps you to understand the loan working by reflecting the exact EMI that is payable.
• You may track the amount from the EMI that is allocated towards repaying the principal and the interest.
• It updates the outstanding loan balance after every EMI is paid.
• You may calculate the total interest you will pay on the borrowed amount; additionally, you may determine the adjusted interest if you pay more than the EMI during a particular month.
• The amortization schedule allows you to calculate the total interest paid during the financial year, which can be claimed as tax deductions for certain types of credit facilities like home loans.

What Is Personal Loan & Credit Score?

Some types of loans like home and car loans have to be used for the specified purpose only. A personal loan is a type of facility wherein there is no limitation on how you can use the borrowed amount.

You can use the money to pay for a holiday, wedding, education, or for any other purpose.

Most financial institutions offer unsecured personal loans, which means you do not have to provide any collateral to avail of the money.

As the risks in case of default are higher, lenders often charge a higher rate of interest when compared to secured loans.

A credit score evaluates different aspects of your credit history to show your creditworthiness. There are several credit bureaus that maintain your credit score, which ranges between 300 and 900 depending on the agency.

A higher credit score is seen as favorable and lenders may grant you a higher loan amount or an affordable rate of interest when you avail of a personal loan.

On the other hand, if your credit score is low, the lender may charge a higher rate of interest and in some extreme cases may even not approve your loan application.

How Loan Repayment Affect Credit Score?

Irrespective of whether you avail of a secured or an unsecured loan, repaying the borrowed amount is important. Any delay or default in repaying the money negatively impacts your credit score.

Lenders report missed or delayed payments to the credit bureaus, which in turn reduces your score. This may become a problem in the future if you apply for another loan or a new credit card.

If you have a history of multiple missed or delayed payments, there is a possibility the lender may reject your application.

Advantages of Loan Prepayment

Some benefits of prepaying personal loans include:

Interest savings

Compared to secured loans, the interest on personal loans is higher. Therefore, if you repay the loan before its tenure, you can significantly reduce the interest outflow resulting in huge savings over the long term.

Lower debt

Having no debt reduces your stress and allows you to attain financial independence. Additionally, the risk of financial failure is eliminated, and you have more disposable income that can be used for meeting other purposes.

Increased credit score

Clean credit history and high credit score improve your loan eligibility. Repaying a personal loan before its due date has a positive impact on your credit score and helps you to negotiate better terms if you apply for another loan in the future.

Home loan repayment rules

There are no fixed rules to repay a home loan; generally, lenders may allow you to prepay a partial amount either monthly or annually.

It is recommended you set aside an additional amount each month over and above the EMI to make partial prepayments on the outstanding home loan balance.

Making partial prepayments at periodic intervals reduces the outstanding principal amount. The future EMIs are recalculated at the lower principal outstanding.

Therefore, you are able to reduce the interest outflow and over the long-term can enjoy significant savings on the total interest paid.

Education loan repayment rules

Lenders offer education loans to pursue further studies either in India or abroad. The basic eligibility criteria include educational history, capability to repay the loan, and future opportunities for a job and income.

Based on the lenders’ policies, you may get a moratorium wherein you do not have to pay the EMI.

The moratorium can be up to 12 months after completing your studies or six months from the date of starting a job.

Before you make a decision, ensure you get the student loan calculation table to check the moratorium, EMI, and other payment terms.

Although lenders offer a moratorium on education loans, it is recommended you start repaying at the earliest.

The rate of interest on such loans is often high and the moratorium is not an interest-free period, which means you need to pay the interest even during this time.

Since you do not make any payments towards repaying the principal during the moratorium period the overall interest outflow over the loan duration increases.

The procedure for education loan repayment is simple. You can contact your lender to start an automatic debit.

The loan duration varies from one lender to another and most financial institutions do not levy prepayment penalties if you foreclose the loan.

However, section 80E offers tax benefits on the education loan interest, and prepaying may not be advisable.

How to Calculate Loan Repayment?

The loan payment calculation depends on the borrowed amount, tenure, and rate of interest. The principal amount is spread over the loan duration along with the interest.

The total amount is then divided by the total months over the entire tenure. You can use an online calculator to determine the monthly installment.

When you borrow money from any financial institution, you must repay it along with the applicable interest over the loan duration. Making repayments on time ensures you do not fall into a debt trap and also positively impacts your credit score.