Knowing what is loan foreclosure in detail is important- Early prepayment of the outstanding loan balance in advance of the due date. A personal loan normally has a lock in of about 1 year after which the entire balance amount can be prepaid. This personal loan can be prepaid or paid partly and there are certain advantages in store for the customer.
When the borrower has a lump sum amount left idle which is not equal to the entire principal balance amount that’s were part payment works. How? It brings down the principal amount that is unpaid, which in turn also brings down your EMIs and the total interest you pay. It is important to know that this works only when you make a significant amount as part payment (Lump sum).
Foreclosing or pre-closing a loan can happen either from the borrower side or from banks side.
Foreclosing from the Bank Side:
This happens only when the borrower doesn’t repay the amount in regular EMIs. The bank will be forced to auction the property on which borrower had taken the loan. By selling the property, bank will foreclose the loan when it gets the money from auctioned property, as the borrower is not financially sound enough to pay back the loan amount.
Foreclosing from the Borrower’s Side:
In most of the cases, people choose to close their loan in advance just to have the feel of being debt- free but it can turn to be a bad decision, so before you choose to foreclose your loan, make sure you check thoroughly with the bank with the below terms and conditions.
- Is it possible to foreclose the loan? Not all banks encourage foreclosing the balance amount before the given date.
- What are the Fore-closing charges? You will need to pay some pre-closing charges for most of the loans (except home loan). And the foreclosing charges may range from 3% to 6% on the balance principal amount that is to be paid.
- When can you foreclose your loan? As per personal loan normally the borrower can prepay the loan amount only after paying the EMI for 1 year.
As mentioned earlier most of the banks will not allow the borrower to pre-close the loan within 6-12 months from the first month of the loan i.e. the start date. By the time you finish paying for 12 months, you might have ended up paying a major portion of the interest amount and very little saving would have gone towards the principal of the loan amount.
So, the trick is to prepay the entire amount as early as possible in the tenure of the loan so that the borrower can expect the advantages of foregoing less on interest. However, even if the customer may have paid much of the interest for many months and does have some extra cash, it is always the best to prepay the loan and get the debt off your shoulders.
The RBI had recently directed banks to stop pre-closing charges to the customers, but this only applies to loans taken on basis of ‘floating rate’. Since most of the personal loans are on a fixed rate basis, the rule does not imply. However, there are some public and private sector banks that do not charge for prepayment. In such case, there is a great benefit to the borrower; he can make use of that cash in paying off the loan. If idle cash in your hand can earn you less return then why keeping the loan in the bank or investing it elsewhere when compared to the interest you pay on the personal loan, it would be wiser to pay your personal loan in advance.
Few of the things that you would require to carry when you approach for the pre-closure of personal loan: ID Proof, Cheque / DD for pre-closure, Loan Account number.
Pre-Closure Acknowledgement Receipt:
- Once you hand over the payment make sure to collect the pre-closure acknowledgement receipt for the same. Avoid using cash to pre-close.
- If in case your next EMI is very close, there are chances for the loan to get processed, so make sure the bank credits it back soon to the account.
- Within 2 weeks, you should be confirmed on the pre-closure of your personal loan.
Pros of Foreclosing of a Personal Loan
Result to savings
One of the biggest advantages of foreclosing a personal loan, where the lenders charge a high rate of interest is a considerable saving. Its a fact that when you go for a personal loan foreclosure you will definitely save some amount.
A personal loan is one of the quickest available loans without any collateral hence the interest payable for a personal loan is generally higher than any other loan and usually starts with a minimum of 15% per annum. When you start paying your EMIs you pay a major part of the interest initially and as a result, your principal reduces slowly. Hence, if you prepay your loan and foreclose it, it will result into saving a lot which you could have paid on the interest.
End of any loan definitely gives a positive psychological impact on the borrower. It brings a sense of relief and foreclosing a higher interest loan is definitely a morale booster. Ending a loan gives you a confidence in being financially in control and also gives a sense of satisfaction.
Cons of foreclosing a Personal Loan
Can be a Breaker for other opportunities
Foreclosing a personal loan means you need to repay the whole outstanding amount in one shot. This requires a huge amount which can be a loss for other opportunities. Instead of foreclosing the loan one can use the same amount for many other stuff such as for investment, which can give you much better results in future, can be used or saved for child’s higher education and many more.
Apart from the outstanding amount you need to pay a foreclosure charge in terms to foreclosure your personal loan. This charge plays a major role in deciding whether you should go for a foreclosure or not. If your outstanding amount is not much then opting for a foreclosing can cost you much. Hence, one should only go for a foreclosure when your savings on a foreclosure is a considerable aount including your expense on the foreclosure fees.
Impact on the CIBIL Score
Your timely payments against your loan have a positive impact on your CIBIL Score whereas foreclosing a personal loan may cause a sudden fall in your CIBIl. Hence, don’t forget to consider this fact if you think you may need a loan in the near future as a foreclosing a loan will affect your CIBIL and hence your future creditworthiness.
Lock in period
Depending upon the loan terms and conditions, you may not be able to foreclose your loan account due to that lock-in period clause. Hence, it is advised to check the important aspect with your lender before coming to a final conclusion.
Would like to wrap up the article with an adage, one should borrow as little as possible and repay as quickly as possible. This holds good for personal loans, as the high interest rates can be a big rip off to many. So, if you can prepay or part pay a loan, it’s the best to go for even without thinking much.
(Updated – 09-08-2018)