All You Need To Know About Personal Loan Foreclosure
Personal loans can be a beneficial tool for managing short-term financial ventures and emergencies. However, as with any loan, this comes with a burden of debt which can be very stressful.
Foreclosure can be an excellent option to get out of debt for someone who observes sudden financial growth, although it comes with a few strings attached. In this article, we will be discussing what foreclosure or prepayment of loans is and what to keep in mind if someone wishes to avail it.
What is the foreclosure of a personal loan?
Foreclosure of a loan, also known as prepayment, is the choice given to their customers by banks and other financial institutions which lets them repay their outstanding debt before the predetermined tenure of the loan expires.
Let’s take, for example, a case where someone takes a loan from a bank at x% rate of interest that is due to be paid back in 5 years.
Now, if that person experiences a sudden increase in their income in the 2nd year of the tenure, which gives them ample money to pay the loan back immediately, they can do so by the 2nd year.
Advantages of availing of personal loan foreclosure:
Be free of the debt burden quicker:
Personal loans are taken for immediate financial emergencies or a temporary economic boost. Once that need passes, it is a pragmatic choice to repay the debt owed at once, if possible for the borrower.
The monthly EMI will be a constant financial drain, including a significant interest amount. Therefore, if you come across a substantial source of monetary influx or if the initial project requires much less money than previously assumed, then availing of foreclosure and paying back the entire debt would be the smart move.
It is to be noted that most financial institutions charge a prepayment fee from the customer. However, in maximum cases, that penalty is not significant. Given that it allows you to escape the prison of indebtedness, that fee is indeed very much worth paying.
Foreclosure can lead to a significant reduction in interest outflow:
There is something called the lock-in period. This is a technical term used to denote the minimum amount of time that must elapse before the customer can avail of prepayment options, either partial or the total loaned amount.
After the lock-in period passes, the customer can claim foreclosure of the personal loan if they choose to. If you prepay the entire amount or part of it, it’ll go a long way to save you money in the long run. When you make the prepayment, you cut down on the number of months left in the tenure, bypassing the interest payable for each of the monthly installments, and partial prepayments cut down on the principal amount on which the interest is to be calculated.
The overall debt can be decreased through partial prepayment:
If you come across some extra money that is more than what you need at the moment but not quite enough to prepay the entire loaned amount, it is still advisable to use that sum of money to pay part of the debt.
This has two benefits. One, it pays back part of the amount that is due. Two, as the interest is calculated based on the outstanding principal to be paid, the amount payable per month decreases as interest.
It is advisable to avail prepayment options as early in the tenure as possible to reap the maximum potential benefits.
Prepayment will improve credit score:
Depending on your transaction histories and debt payment habits, a credit score marks your financial reliability and trustworthiness calculated by banks and the like.
While making prepayments, one essentially clears outstanding debts in one fell swoop. As soon as the debt is cleared, wholly or partially, the credit score gets improved.
With this improved score, the bank recognizes you as someone who always pays their debts, thus improving the chances of future loan applications from you getting approved immensely.
Disadvantages of availing of personal loan foreclosure:
Having to make a lump sum payment:
The fundamental prerequisite of personal loan foreclosure is having enough money ready at hand to be transferred to the bank at a moment’s notice. For most people who take personal loans in the first place to avert an economic crisis, it’s very unlikely that they will have access to such ready money anytime soon after getting the loan.
The prepayment penalties charged by the banks:
The banks and NBFCs get money at much lower rates than the rates they charge as interest from the customer. This difference between the borrowing and lending values is what these financial institutions earn as income. This profit-earning continues for as long as the loan tenure lasts.
Now, if a customer cuts short the tenure by opting for full personal loan foreclosure or decides to reduce the principal loan amount by making a partial prepayment, then that decision negatively impacts the banks’ income.
Banks essentially charge prepayment fees to make up for this loss that is incurred. Before opting for a prepayment plan, it is crucial to evaluate the bank’s interest rate against the prepayment penalty. One must go for prepayment only if the profit gained by bypassing the interests outweighs the cost imposed by the prepayment penalty fee.
How to cope with the foreclosure penalty?
There are several factors upon which the prepayment penalty depends.
- It depends on the particular stances specific to the institution.
- It can depend on the time left from the tenure.
- Certain financial institutions allow personal loan foreclosure without any penalty being charged after three years have elapsed in the tenure. Others do not abolish the penalty altogether but give discounts depending on when the foreclosure is opted for.
Now, if you take a personal loan, it is practical to assume that it is more likely for you to have no access to a lump sum of money in the near future. As such, if you come across a personal loan plan which offers low prepayment penalties but has high-interest rates to compensate for that, it is advisable to avoid that scheme. The money drain from interests will be tremendous in the long run if you cannot avail of the prepayment option.
It is a smart move to choose a scheme with low-interest rates since even if you get charged a higher prepayment penalty in comparison, the money saved from the interest would far outweigh the foreclosure fee.
In any case, availing of the most suitable personal loan scheme depends on the unique situation of each customer and their particular plans and possibilities. Prepayments are viable options only if there is a possibility of major incomes for the individual in the near future.
If you have decided to take a personal loan, you will most likely want to stick to the pre-planned loan scheme and make the monthly payments in installments until the tenure expires.
However, if you are in a position to opt for foreclosure, it is essential to remember that foreclosure takes off the burden of debt swiftly from your shoulders while simultaneously making it possible to incur some savings. Loan foreclosure schemes also boost your credit scores significantly at one go.
So armed with all this knowledge, borrow wisely, spend wisely and use wisdom to pay back your debts too.