Personal loan is one of the most demanded financial products in the country mainly because of the flexibility it offers. One can take personal loan to tide over emergency expenses or to meet other long-held-up needs such as home improvement, buying a fancy gadget or a world-tour. Though most of the people consider interest rate as the only deciding factor, it is also important to be aware of the personal loan prepayment charges.
Risk aversion is a traditional trait of most of the Indians and, more often than not, they wish to pre-pay the debts whenever their finances allow. Although this anxiety to pay-off debts before time might bring mental peace for the borrower, the financial benefit of pre-payment depends on several other factors. In this article, we will talk about when it is advisable to pay off the personal loan before time.
Pre-Payment in Full
If you are thinking of making full payment of your debt before time, it is wiser to do it in the earlier stages. However, you should know that most of the banks have a lock-in period of one year, only after which you can pay-off the entire outstanding amount. A better part of the interest cost will be paid by you during the lock-in period. Let us understand this with the help of an example-
Suppose you take a personal loan of Rs 4 Lakhs for 3 years at a rate of 14%. The EMI payable by you per month will be Rs 13,671. The total interest to be paid by you during the loan term will be Rs 92,158. However, this loan has a lock-in period of one year and in the first year you cannot make any pre-payment.
Now, if we calculate the total interest paid during the first year it will be equal to Rs 48,790, that is, approximately 52% of total interest cost. The table given below shows the amount of interest paid each year.
|Interest||Percentage of Total Interest Cost||Interest Saving|
It is evident from the table given above that the sooner you pre-pay, the more interest you save. In this case, if you pay the entire debt as soon as your lock-in period is over, you can save nearly 47% of the interest cost which would total up to Rs 43,368. Even if you pay at a later stage you will save a substantial amount of interest cost.
Another important thing that you should consider at this point is the pre-payment charge levied by your bank. Most of the banks levy penalties ranging from 1-4% of the outstanding amount. The table below shows pre-payment charges levied by some popular banks-
|ICICI Bank||5% per annum of principal outstanding plus GST|
|Bajaj Finance||4% along with applicable taxes on outstanding principal|
|Citibank||Up to 4% on total principal outstanding at the time of calculating the amount for full and final settlement of account; plus, interest for the ongoing month.|
|HDFC Bank||13-24 Months – 4% of Principal Outstanding
25-36 Months – 3% of Principal Outstanding
>36 Months – 2% of Principal Outstanding
Part-Payment of the Loan
If your budget does not allow you to pay the debt in full, you can use your idle money for part-payment of your personal loan. Making part-payment is advisable as the amount you pay gets directly deducted from the total outstanding principal amount. Since the interest is charged on the outstanding amount, you will make considerable savings when the principal comes down. However, you should make partial payment when you think that it help you save enough.
In the above example, if you pay off Rs 1,00,000 as soon as the lock-in period ends, you can save a significant interest cost. In the first year, you have paid off Rs 1,15,263 and the remaining principal amount is Rs 2,84,737. Out of this amount, if you make part payment of Rs 1,00,000, the outstanding principal amount will come down to Rs 1,84,737. The interest will now be charged on the new outstanding amount.
The best thing about making partial payments is that it can be done a number of times. However, most of the banks put a cap on the number of times part-payment can be made and also on the amount of payment, usually in terms of percentage of the outstanding amount. Hence, borrowers should check these at the time of taking the loan.
The Bottom Line
Pre-payment can be beneficial if you make it during the initial stages of the loan or as soon as the lock-in period ends. In case your bank charges penalty for pre-payment or part-payment, compare the amount you save with the cost of pre-payment and then proceed. It is always advisable to discuss the terms of pre-payment before signing on the dotted line.