InvestorQ : I wish to prepay my personal loan. How should I go about it?
Abigail Ghoshal made post

I wish to prepay my personal loan. How should I go about it?

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priya Shah answered.
3 years ago
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Prepayment of your loan can be done in two ways, depending on your availability of funds:

- Full prepayment of loan

- Part prepayment of loan

Based on how much excess funds you have and how comfortably you can mobilise it, you can choose either of the two options.

If you choose to prepay your personal loan, there are two ways to do it. Either you pay the loan amount partially or fully. Let’s consider each case on a hypothetical situation and check whether the result turns out to be beneficial or not.

Hypothetical situation: Suppose that you have taken a personal loan of Rs. 5 lakh for four years at a rate of 15% per annum. The loan EMI payable will be Rs. 13,915 and the total interest to be paid by you during the loan term will be Rs. 1,67,938. Furthermore, the loan has a lock-in period of one year, which means you cannot prepay any amount before a year.

Scenario #1: If you make full pre-payment

As stated above, banks usually have a lock-in period of one year on personal loan. This means you cannot prepay a loan until a year from your first EMI. The rationale for this is that a better part of the interest amount is charged in the initial period of the loan tenure.

The following table depicts the interest amount that was paid each year.

No. of Years

Principal Amount

Interest Amount

% of Total Interest Cost

Interest Saving

1

Rs. 98,579

Rs. 68,405

40.73%

Lock-in Period

2

Rs. 1,14,427

Rs. 52,558

31.30%

Rs. 99,533 (59.27%)

3

Rs. 1,32,821

Rs. 34,163

20.34%

Rs. 46,975 (27.97%)

4

Rs. 1,54,173

Rs. 12,812

7.63%

Rs. 12,812 (7.63%)

As you can see, in your first year of lock-in, the interest payable will be Rs. 68,405, which is over 60% of total interest cost. From the second year onwards, the interest amount starts decreasing, provided the EMIs are paid on time. Thus, from the table above, it is clear that repaying your loan sooner will help you save on your interest amount.

If you start paying in the first month of your tenure’s second year, you can save about 60% of the interest amount. Do note, however, that even if you do decide to prepay your loan in the latter years of the loan tenure, you will be able to save a significant amount of interest.

Scenario #2: If you make part prepayments

Part prepayment is when you repay only a part of your outstanding balance to your lender in advance. This differs from full payment as in full payment, a borrower repays the entire outstanding balance amount in one go.

Some banks allow their borrowers to partly prepay their personal loans, while some don’t. For instance, ICICI Bank does not offer part pre-payment facility, while HDFC Bank does allow it. The rates for part pre-payment facility vary from one lender to another, therefore, one must consider the related charges before availing personal loan.

Pre-payment charges of some popular banks

Bank

Pre-payment charges

HDFC Bank

13-24 months – 4% of principal outstanding

25-36 months – 3% of principal outstanding

>36 months – 2% of principal outstanding

ICICI Bank

5% per annum of principal outstanding

YES Bank

13-24 months – 4% of EMI repayment

25-36 months – 3 % of EMI repayment

37-48 months – 2% of EMI repayment

>48 months – Nil

Kotak Mahindra Bank

Up to 4% on total principal outstanding at the time of calculating the amount for full and final settlement of account; plus, interest for the ongoing month.

Let’s take the same example. If you pay off Rs. 1,50,000 immediately after the lock-in period gets completed, that is after 12 EMIs, you can save on the interest amount considerably. Let’s understand this better:

As per the table given above, you have paid Rs. 98,579 in the first year of the loan tenure, which is also the lock-in period. This leaves us with Rs. 4,01,421 as the remaining principal amount. Now, if you part repay Rs. 1,50,000 immediately after the lock-in period ends, then the outstanding balance will further drop to Rs. 2,51,421. This means that in the second year of your loan tenure, your lender will calculate interest on this new outstanding principle amount, which is significantly lower than the previous amount.

Do note, it is not necessary that you save on the interest amount only through full prepayment. If you do not have sufficient money to prepay the outstanding amount in full, you can even consider the part pre-payment option. Whatever amount you decide to pay will get deducted from whatever total outstanding amount you have on the loan, thus, saving a considerable interest amount when the principal amount reduces.

So, if your finances allow, you can prepay more than once in your loan tenure. However, many banks and NBFCs restrict on the number of times borrowers can part prepay the loan amount. Therefore, you must check all rates, charges and related clauses concerning your personal loan before signing the dotted line.

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