Foreclosing Your Personal Loan: The Pros And Cons You Must Know

Life is not always a cakewalk; there are good times and then there are also bad times that we need to face with grit and courage. Sometimes, you may come across a situation where you may have to look beyond your existing financial means to overcome a hurdle. At such times, a personal loan can be a great saviour. These loans are available easily and offer flexibility in terms of tenure, usage, and repayment.

And then, when your financial situation turns around, you have the option to foreclose or pre-pay your personal loan to enjoy a debt-free life. However, before you pay off your personal loan in advance, you must weigh all the pros and cons of personal loan foreclosure.

Let’s take a look at the positives and negatives of foreclosing your personal loan, so you can make the right choice.

• Saves on interest cost

  One of the main reasons for paying off a personal loan early is to save on the overall interest cost. For example, if you have a personal loan of ₹5 Lakh with an interest rate of 13% per annum for a tenure of 5 years, the resulting EMI outgo would amount to ₹11,400. In this case, your overall interest cost would be close to ₹1.83 Lakh. Now, after 2 years, if you decide to fully pre-pay your loan, you will end up saving about ₹72,000 in interest costs. However, you must factor in the personal loan pre-payment fee and other costs (if any) before foreclosing your loan. Consider opting for a personal loan foreclosure only if it results in substantial overall savings.
  
  

• Increases EMI Affordability

  Banks and NBFCs prefer providing personal loans to applicants whose total EMI outgo, including both existing and new loans, are within 50-60% of their total monthly income. So, prepaying an existing personal loan can improve your loan eligibility. Foreclosing your personal loan lowers your monthly loan repayment obligation, thus improving your affordability to pay EMIs of any new loans.
  
  

• Reduces Concentration Of Unsecured Loans In Your Credit Mix

  Your credit mix is the ratio of your outstanding secured and unsecured loans. Credit bureaus factor in your credit mix while computing your credit score. Most lenders prefer providing loans to borrowers with a higher concentration of secured loans (loan against property, home loan, car loan, etc.) as compared to unsecured loans. Since personal loans are unsecured in nature, foreclosing such loans will reduce the concentration of unsecured loans in your credit mix, thus increasing your credit score.

• Prepayment Charges
  RBI has barred all loan providers from levying prepayment fees on loans that have been availed at floating interest rates. However, loans with fixed interest rates have no such restrictions. Hence, most lenders levy a prepayment fee on loan prepayment of up to 5% of the principal outstanding amount. Some lenders also restrict the pre-payment before the borrower repays a predetermined number of EMIs.
  

• Impact On Liquidity
  Many borrowers use up their emergency funds or investments earmarked for important financial goals to foreclose personal loans due to the burden of high interest rates. However, if you do this, it can impact your capacity to deal with any financial emergencies like illness, job loss, etc. Tapping into your investments earmarked for crucial life goals can lead to availing loans at a higher interest rate later on. Hence, you must opt for foreclosing your personal loan only if you have adequate surpluses apart from your emergency fund and monthly investments made towards long-term financial goals.

Before you decide to foreclose your personal loan, it is important that you consider all the factors discussed above. You must opt for a foreclosure only if you are gaining significantly from the entire transaction. 

Also Read: How To Get Tax Benefit On Personal Loan?