Should You Go For Personal Loan Prepayments?

On Nov 27, 2021

There comes a time in every person’s life when they must borrow a private or institutional loan to tide over a crisis, or to buy an asset. People borrow instant personal loans to fund emergencies or to pay for expensive items without disturbing their income. Meanwhile, home purchase and home renovation loans are borrowed for large sums of money that one may not have in their bank accounts.

Once the loan is borrowed, one enters a loan cycle comprising monthly EMIs (Equated Monthly Instalments) that repays the borrowing over a pre-decided tenure (in months or years). Each EMI is divided into a percentage of the principal borrowing and the interest levied on it.

Financial experts believe that though it may be imperative to borrow a loan to fulfil a need, it is equally imperative to eliminate the borrowed debt from one’s life as soon as possible. This must be done without depending solely on the EMI schedule, via prepayment.

What does loan prepayment mean?

Loan prepayment is not to be confused with the term ‘loan repayment’, though they are roughly the same. Prepayment is the process of paying back more than the monthly EMI amount. It is entirely up to you to decide the frequency and amount of prepayment.

For example, consider a loan borrowing of Rs 50,000 with a monthly loan EMI is Rs 4,000. If you decide to prepay, you might pay a sum of Rs 5,000 for a few months, i.e. Rs 1,000 extra. Or you might pay the lender a lump sum amount of Rs 20,000 during the loan tenure, so that the overall principal comes down to Rs 30,000 (Rs 50,000 – Rs 20,000).

What are its benefits?

Loan prepayment is a good financial practice for the following reasons:

It reduces your loan burden faster. To cite the example stated above, suppose you pay a large chunk of the principal during the loan tenure. It reduces the principal borrowing dramatically. If you do this often enough, the loan is repaid faster than its tenure
Since you end up repaying the loan much faster, you save considerably on the interest levied on the loan. Each EMI payment comprises of principal + interest, hence the faster you pre-pay the loan, the more you save on repaying interest to the lending institution. Do note that the interest rate on unsecured loans like instant personal loans is much higher than that of secured loans like home purchase loans or home renovation loan.
Regular pre-payments keep you focussed on your strategy and prevent you from spending your income on unnecessary or trivial pursuits. Otherwise, you might be lulled into a false sense of security – you might stick to the repayment schedule and pay monthly EMIs without a thought to how much interest you are paying.
Pre-payments increase your credit score and improve your repayment record. Lending institutions, from banks to loan apps, are happy to extend loans to applicants with a history of early foreclosure. These applicants are viewed as ideal, low risk candidates for various loan products.

How to prepay your loans

Now that you are aware of its benefits, let’s look at the ways you can pre-pay your debt:

Start with a strategy. You cannot prepay your loans if you don’t have a clear repayment strategy in mind. Check how much you still owe the lending institution, how many more months of EMI payment are left, and work backwards from there.
You can set aside a portion of your income every month so that the savings can accrue enough money to make regular prepayments.
Divert any additional earnings (bonuses, annual increments, cash gifts from relatives) towards loan prepayment.
Curb all unnecessary expenditure for a few months and set a spending budget for essentials like utility bill payments and groceries. Stick to the budget strictly till the loan is repaid entirely.
If you have multiple loans, consider borrowing an instant personal loan to consolidate your debt. However, be sure to pick a personal loan with a competitive rate of interest and which offers enough amount to close old debt. Several lenders have personal loan offers during the festive period – this is the best time to apply for it.