Pre paying your Personal loan
You had an emergency and you needed cash urgently or it could be a case, when you credit card bills broke all limits and your brain went numb looking at the interest you were paying on your amount due. Either way, you ended up with a personal loan which saved the day then, but now it is pinching your pocket real bad. Now you are contemplating on getting rid of it by prepaying the loan from your savings and closing it once and for all, but then would that be a wise thing to do?
Since personal loans in most cases are unsecure loans, which means that banks don't have an asset as collateral against the loan which they can repossess or keep, banks charge a very high rate of interest on loans. This ends up taking a hard hit on the borrower's monthly savings and many people often consider prepaying the loan at the earliest available opportunity.
While clearly pre-paying any loan is a wise thing to do, there are a few factors which one should consider before proceeding:
- Prepayment Penalty: Since banks lose out on a potential sum of money on the interest if you prepay and close a loan, banks charge a high penalty. This penalty can be sometimes as steep as 5%. Before pre-paying your personal loan, get in touch with your bank, and understand what the penalty on pre-payment is. Some banks may be lax on these terms, whereas some banks can impose a heavy fine. At the same time, most of the banks have different stages in the loan tenure and pre-payment penalty rates as per that particular stage. Most banks would allow you to pre-pay the loan for almost no penalty if only 25% of the loan amount remains to be paid.
If you are just considering a personal loan, this is a factor worth considering before finalising the bank from where you take the loan. Go for banks which charge a nominal or no penalty on loan pre-payments.
- Stage in the Loan Tenure: Before prepaying the loan, it is important that one first evaluates at what stage one is in terms of the loan tenure. For loans, all banks start charging the interest on the loan first and the principal amount later on. So if your loan has just started, you stand to gain more by prepaying the loan right then since you can save a lot in terms of the interest. However, if you are nearing the end of your loan tenure, prepaying might not actually be worth it, since you would have already paid for most of the interest. The remainder principal would be required to be paid in any case.
Thus, pre-paying you loan is advisable in almost all cases since it helps you save a lot on the interest to be paid on the loan, sometimes making it worth even the penalty charges.