So you have got some windfall money or a raise in salary. And you are contemplating to pay off that Personal Loan where you have been paying a high rate of interest. Getting rid of a high rate of interest loan logically makes sense. But as every coin has two sides, so does a foreclosure would have its own pros and cons.
But before you go through the list of considerations that you must deliberate upon prior to arriving at a decision, let us look at an example to put things in perspective. Following is the table on a hypothetical situation where the customer has served the EMIs for 15 months on a Rs 200,000 loan.
|Rate of Interest||
|Term of Loan (Months)||
|Total Savings on Interest||
Pros of fore closing a personal loan
Leads to saving
The biggest advantage when you foreclose a Personal Loan, which is typically a credit line where the lender charges high rate of interest, is the considerable savings that you are able to make. In the above example, the interest while is only 15%, the actual interest repaid in first 15 months is more than the principal amount and in the above scenario if the loan is continued to be served for full term, an additional interest of about 34% on the current principal outstanding will get paid.
Therefore, if only this condition was to be taken into account, it makes the decision ability quite easy. But there are other factors as well that need to be pondered upon.
End of a loan definitely has a positive psychological impact. It gives a sense of relief and fore closing a loan will be a definite morale booster. Not only it gives you the confidence on being financially in control but also gives a sense of satisfaction.
Conclusion of one EMI will also enhance the disposable income. You would be able to put the available funds to better use. Maybe start to invest the amount or utilize the same to pay off other debts faster. In the above example, the EMI of Rs 4,854 gets to add into the disposable income which if invested in mutual funds has the potential to yield a return of about 12% annualized return (this assumption is based on the average historic return provided by such investments). This can help in building a sizable corpus over years and assist in meeting the retirement or long term financial goals.
Cons of fore closing a personal loan
Loss of corpus
A bigger directed towards investment can lead to giving a boost to the corpus being invested for a child’s education, saving money for the down payment of your dream house, getting to create that exigency fund or even fulfilling your desire of taking a good vacation with family. While the pre-payment of that loan will boost the disposable income on a regular basis but the availability of large amounts will have its own merits.
Unlike a home loan, a personal loan carries a pre-payment charge. This ranges from 3 to 5 percent depending upon the bank’s policies. You must check this out with the lender prior to closing the loan. An outflow of such high charge will only increase the overall cost of the fund.
Some banks may provide a waiver on pre-payment in case a partial payment has been initiated. So it is advisable to check with the bank on same.
More importantly, the foreclosure may not make much sense in case you are already nearing the end of the loan term. As we all know that a higher part of EMI gets adjusted towards the principal outstanding as the vintage of loan increases and paying a fore closure charges will not be advisable.
Impact on credit score
This is one important consideration to be taken into account. Each active trade line and its vintage has a positive impact on the credit profile. Closing loans may lead to fall in your credit score and inactivity may lead to you looking for personal loan for low CIBIL score
Lock in period
Depending upon the loan terms, you may even not be able to close the account due to that lock in period clause. It is advisable that you must check on this important aspect with your bank before coming to a conclusion.
Fore closure of a personal loan while on one hand has its own merits, it may not be the right thing to do in case you find yourself struggling to keep control over your expenses. In case you are unable to utilize the funds for systematic investment, it is better not to foreclose the loan with that large sum of money available with you at this point of time. Rather you should be investing it for future.
The post Want to close the personal loan earlier? Check out the pros and cons appeared first on Credit Sudhaar Blog.