Loan Pre-payment Update: The decision to take a loan is often the result of unavoidable circumstances, but once that decision has been made, how to repay the loan becomes an equally important concern. Among various loan repayment modes offered, one of the popular ones is loan prepayment. Borrowers often ask themselves, “When does one consider prepaying an outstanding loan?” when they find themselves in a situation where they have enough cash at hand.
Although beneficial, borrowers must understand the outdated disadvantages related to prepaying loans. Many people believe that clearing a loan off early will free them from the freed finances, however, hidden hurdles can be brought into the light through fees, penalties, and impacts on credit scores. So, let’s take a stronger insight into the benefits and disbenefits of prepaying a loan and what a borrower needs to know about it before they indulge in the act.
The Bank Charges on Loan Prepayment: Know It All
Most banks and financial organizations charge additional fees for prepayment or foreclosure of loans. The fees usually range anywhere from 1% to 5% of the outstanding loan amount. Although it may seem to be a discouragement, the amount saved is quite considerable, particularly because, in the case of a high outstanding amount, it is a huge amount gifted by the bank.
This is because, by reducing a part of the principal amount in advance, the amount of time during which the costs are accumulated is shortened, resulting in these funds having long-term savings benefits. It is, however, important to do the math to see whether prepayment costs are better than the interest saved.
Impact of Loan Prepayment on Your CIBIL Score
Prepayment of loans has a mixed impact on the CIBIL score. While it positively enhances the score because early closure of loans portrays financial discipline and increases your creditworthiness, it shows lenders a loss of their expected income by way of interest for an early closure or single time full payment, which will dent your score slightly.
In addition, should you apply for another loan in the future, having no more open loans left will help you. Based on the existing debts, lenders evaluate the repayment capacity of a person, so early closing of a loan might be better for you when it comes to getting better financial assistance.
When Does Prepayment Save You Interest?
The main feature of prepayment with loans is determination by time. If you have a loan that is based on the prepayment of the loan amount at an early stage, in which the principal amount is not reduced much, you will save the maximum in the interest amount.
If much of the loan has already been paid by you, not saving much in the interest amount, prepayment charges will not justify the decision. Therefore, it is important to assess the status of the loan and find out the savings before going in for prepayment.