Personal loans are one of the most popular ways of managing finances for most people. They can be used for various purposes, such as funding education, covering wedding expenses, expanding business, dealing with medical emergencies, etc. Most people obtain a personal loan to finance their needs.
Generally, a longer loan tenure means that the monthly EMI is less, but it also means that the cost of borrowing increases as we end up paying more interest over the loan period. But, if you have some extra money during the loan tenure, a great idea would be to pay off the existing loan before using it for any other purposes or investing it. It is a dilemma for most of us how to use the extra money, but paying off a personal loan early has many benefits. You just need to be aware of the penalties or early repayment charges and conditions of your loans.
Personal loan foreclosure helps in saving money on interest charges. The details of what foreclosure of a personal loan is, charges, drawbacks of early repayments, how to repay a loan earlier, and itsdrawbacks are all discussed in this article. This information will help you decide what best suits you and aligns with your financial goals.
What Is Foreclosure of Personal Loan?
When you repay the entire amount of a personal loan earlier than the decided period, it is known as a personal loan foreclosure, or loan prepayment, or pre-closure. You can save on interest payments and reduce your financial burden if you opt for foreclosure of your personal loan. If you decide to pre-close your loan, make sure to review the terms and conditions of your loan, as there are certain foreclosure charges on personal loans. So, when you settle your loan account for foreclosure, the amount would include any outstanding principal amount, interest due till the foreclosure date and foreclosure charges as applicable. Remember to collect the No Objection Certificate from your lender as it is proof of foreclosure of your personal loan.
Types of Foreclosure
There are two types of personal loan foreclosures in India:
- Bank-Initiated Foreclosure: If you are irregular with your repayments or default on your EMI, the lender may initiate foreclosure of your personal loan. The lender will also send you a legal notice asking you to repay the outstanding balance.
- Customer-Initiated Foreclosure: When a customer is able to arrange money and decides to repay the loan earlier and become debt-free as part of their financial management, it is a customer-initiated foreclosure of a personal loan.
Benefits of Foreclosure / Pre-closure of Personal Loan
There are many advantages of foreclosure of a personal loan:
- Interest Savings: The interest charges on personal loans increase the cost of borrowing significantly. So, when you pay off a loan earlier, you can save a lot of money, which would have gone into the interest payment. So, interest savings is one of the biggest advantages of foreclosure of personal loans.
- Reduced Financial Burden: It is true that any loan taken comes with the stress of paying monthly EMIs and interest charges. So, if you have some extra income or cash and manage the foreclosure of your personal loan, you become debt-free earlier, and your financial burden is reduced.
- Increased Loan Eligibility: With the pre-closure of your personal loan, you do not have any other liabilities, so you are easily able to obtain a new loan when you need to. This increases your eligibility to avail of a new loan.
Potential Drawbacks of Foreclosure / Pre-closure of a Personal Loan
While foreclosure of personal loans does help you save money and become free of your debts sooner, it does have a few drawbacks, too. Some of the disadvantages of pre-closure of a personal loan are:
- Prepayment/Foreclosure Penalty: Foreclosure may involve foreclosure charges on personal loans or pre-closure penalties. You should consider these charges and penalties before deciding to foreclose your personal loan.
- Missed Investment Opportunities: When you have extra money, you have to choose between investing the money in mutual funds, stocks, SIPs, etc. or paying off your personal loan and becoming debt-free. When you decide to opt for foreclosure of your personal loan, you are losing on the investment opportunities and their potential returns.
- Loss of Tax Benefits: Some personal loans, such as home or education loans, offer tax benefits on the interest paid. So, if you pay off the loan earlier, you will miss the tax benefits. Thus, consider all the factors carefully before opting for foreclosure of your personal loan.
Is Pre-closure of a Personal Loan Advisable?
It is always nice to be debt-free and not worry about monthly EMIs and interest costs. Still, at the same time, the foreclosure of personal loans has a few catches, and you should be aware of all the terms and conditions before deciding to pre-pay your loan. A few situations where pre-closure of a personal loan would be a wise decision are:
- You Have Extra Funds: When you are able to manage extra money and do not have any other use for it, you can use it to repay your loan earlier.
- Your Loan Has a High Interest Rate: If you are paying very high interest on your current loan, it is better to pay it off earlier.
- If the Savings on Interest are More than Pre-Closure Penalties: If the foreclosure charges or penalties are not very high and the savings on interest are more than even after paying the foreclosure charges, pre-closure of your personal loan is advisable.
How to Foreclose a Personal Loan
Foreclosure of a personal loan is not a difficult task. However, you should clarify the terms and conditions with your lender at the time of availing the loan to have a clear idea from the beginning. For personal loan foreclosure:
- Check your loan documents and go through the loan foreclosure terms and conditions.
- Once you have read the foreclosure terms, you should contact your lender and ask for the total outstanding loan amount.
- You will have to arrange the balance due and make the payment to your lender.
- Once the money is paid for the foreclosure of your personal account, ask your lender for the No Objection Certificate (NOC)
- Lastly, check your credit report.
What are Foreclosure Charges on Personal Loans?
When you decide to foreclose your personal loan, the bank will charge you a fee for the foreclosure. The banks borrow money at a lower price than their lending price. So, after lending, the banks earn the difference between the borrowing and lending amount till the tenure of the loan. When a customer opts for pre-closure, the bank loses on this income plus on the interest charges the bank would have earned during the loan tenure. So, to compensate for this, banks or lenders charge foreclosure charges on personal loans. The fees charged differ from lender to lender.
Common Types of Foreclosure Charges
The lender may charge different types of foreclosure charges, varying from lender to lender. Some common types of foreclosure charges on personal loans are:
- Fixed Fee: A fixed fee may be charged at the time of foreclosing the personal account.
- A Fixed Percentage of the Outstanding Balance: Sometimes, the bank or financial institution charges a fixed percentage of the balance remaining on the loan amount.
- Percentage Based on the Number of EMI Paid of the Outstanding Balance: At times, the charges on foreclosure of a personal loan may be decided based on a percentage based on the number of EMI paid of the balance due.
It is best to know how your lender will charge foreclosure of personal loan charges while obtaining the loan so you avail of the loan with complete clarity. This will help you manage your finances better.
RBI Guidelines on Foreclosure Charges on Personal Loan
The guidelines laid out by the Reserve Bank of India on prepayment charges are:
- Any lender cannot charge penalties on prepayment when the interest rate is floating.
- Lenders can charge foreclosure charges on a personal loan only when the loan is at a fixed interest rate.
- The rules and regulations can differ from lender to lender and for various types of loans.
In conclusion, personal loan foreclosure can be a strategic financial move to save on interest costs and reduce financial burdens. By understanding the benefits, drawbacks, and associated charges, individuals can make informed decisions about prepaying their loans. However, it’s essential to weigh the potential benefits against the potential loss of investment opportunities and tax benefits.
Before proceeding with foreclosure, it’s crucial to carefully review the loan agreement’s terms and conditions, including any applicable prepayment penalties or foreclosure charges. By making informed decisions and considering factors like interest rates, remaining loan tenure, and personal financial goals, individuals can optimize their financial strategies and achieve their long-term objectives.
