A prepayment penalty is a charge that lenders impose if you pay off a part of your personal loan much before your schedule. For example, an individual has taken a personal loan and has been paying the EMIs for the past 2 years. Now, he has decided to pay off a part of his loan. In such a case, he has to pay a specific percentage as a penalty to the lender. Usually, the prepayment penalty on a personal loan begins after a lock-in period that is determined by the lender.
Why do Banks Charge Prepayment Fees?
Banks pay a lower interest rate when they borrow funds as compared to the interest rate they levy when they lend money. The difference between the two rates is the money earned by the bank on the loan. If a customer pays off their loan early, the interest earned by the bank on the remaining period of the loan will be low. The bank will then make up for this loss by charging a prepayment penalty.
The prepayment fee varies across banks, but it is generally between 4% to 5% of the outstanding loan amount. Further, the prepayment fees may differ based on how long the loan has been active. Some banks may not charge any prepayment fees after three years, while others offer decreased rates after a certain period of the loan
How Do Customers Handle Prepayment Charges on Their Personal Loans?
- Customers must not choose packages that give low prepayment fees.
- The prepayment calculator can be used to evaluate the benefits you could get from low prepayment charges.
- Prepayment entirely depends on the financial standing of the customer. If the customer is going to get a big boost in his income, then he can go in for prepayment. Otherwise, it is good to consider packages with low rates of interest.
What Are The Benefits of Personal Loan Prepayment?
- Become debt free quickly: Suppose you have taken a personal loan and you have to repay it. If you default on it, then it will become a financial burden. Personal loan EMIs also take away a good part of your monthly income. This is why when you have extra income coming your way, you should prepay your personal loan fully. Even though you have to pay a prepayment penalty, it is nominal. Prepayment will help you go debt-free and the EMIs will no longer eat up your savings.
- Decreased interest outflow: One of the most important aspects to consider in loan prepayment is the lock-in-period. This refers to the period during which the lender does not accept any prepayments from the borrower, full or partial towards the loan amount. However, once the lock-in-period is over and some extra income is coming your way, try prepaying your loan in full or partial. This will help in saving considerably on the interest amount that you will have to pay even if there is going to be a prepayment penalty.
- Improve Your Credit Score: When you prepay your loan, fully or partially, you are decreasing your debt burden in one shot. This helps in improving your credit score as loans due have a direct impact on your credit score.
- Partial prepayments can decrease your debts: When you partially prepay your loan, it will lower the outstanding loan amount as well as the interest that you will have to pay over the remaining period of the loan. But, ideally it is good to prepay your loan during the early years of your loan tenure.