How Pre-Closure of Personal Loan Can Impact Your Credit Score

Now and then life throws a curveball at us and catches us off guard. In such dire situations, a Personal loan can come to our rescue and steer us clear of financial troubles. The borrowers of personal loans don’t need to back it up with collateral and that’s why they are the go-to choice for most people.

More often than not, borrowers prefer to pre-close the personal loan and shed the weight off their shoulders. Many people pursue this course if they intend to borrow another loan and don’t want to get caught up in the hassle of paying two loans at once. However, the pre-closure of a personal loan isn’t always a good idea.

Does a personal loan affect your CIBIL score? 

Well, the answer to this question is both straight and complicated at the same time. Let us delve deeper into the technicalities to better understand them.

Things to consider before prepaying a personal loan

Debt to income ratio 

The repayment of a personal loan reduces your debt-to-income ratio because your existing debt obligations will be fulfilled. This could come in handy if you intend on taking a new loan. Your loan servicers will assess your debt-to-income ratio and the lower your debt-to-income ratio is, the higher your chances of getting approved for a new loan. The math is up to you, if you are in dire need of getting a new advance from your bank, this option will float your boat.

Savings

While repaying your personal early would remove the ghosts of debt that loom over your head, washing out your savings and hastening to go debt free could prove very risky. Exhausting your savings will make you more susceptible in the face of emergencies. Moreover, you could incur pre-closure charges for the personal loan.

There are always two sides to every coin. Contrary to the popular belief, pre-closure of a personal loan doesn’t get you into the good bank of the bank and much to your surprise, 

it can negatively affect the CIBIL score too.

However, there is no one size fits all kind of solution and everyone’s financial posture is different. Let’s understand the Pros and Cons of pre-closure of the personal and you will be in a better position to assess what fits the bill for you.

Pros 

Most banks or for that matter financial institutions have a minimum lock-in period which is usually one year, however, it could vary depending on your loan provider. Once the lock-in period is over, choosing to prepay the loan is a viable option for you. If you are opting for a pre-closure of your personal loan, this is how you could benefit:-

• Less Interest – If you foreclose a loan early, provided that the lock-in period is over, you could save a substantial interest on EMIs which otherwise would have extended till the loan term. Even if you make a part prepayment, the number of EMIs would get reduced and this would prove more economical for you as you could save a decent amount on interest.

• Debt-free – Another virtue of paying a personal loan early is that you could be having multiple financial obligations at once; car loan, home loan, credit card debt etc. Paying off a loan early will not only shed weight off your shoulders but allow you to channel in more cash flow towards your other loan obligation. Thus, placing you in a position to go debt-free early.

Cons

As we said, no talisman works for everyone when it comes to personal finances. Different things bode well with different people and pre-closure of a personal loan may not always prove to be in your favour after all.

• Impact of prepayment on CIBIL score – You would think that making timely payments towards your loan translates to a good CIBIL score, then paying off your loan early should spell well on your CIBIL score too. Sorry, you are not even close.

When you pay off a loan, your credit report shows a closed account. However, credit bureaus take into consideration your open accounts for assessing your CIBIL score. Timely fulfilment of the active financial liabilities has a more significant impact on your score than the ones closed early. The open accounts are reflective of your past and present debt. Even though the timely payments on your closed loans are a crucial part of your credit history, the impact on your credit score isn’t too significant as they aren’t your current obligations anymore.

Mind you, this logic doesn’t apply to credit card debt. Even if you pay all your credit card debt in one go, the credit card is considered an open account and hence things swing differently in this case.

• Pre-closure charges for a personal loan – You cannot escape prepayment charges even if your lock-in period is over. You have to bear prepayment charges when pre-closing your loan. The prepayment charges could vary from 3% to 6% depending on your provider. However, when pre-closing charges are contrasted against accrued interest during the tenure of a personal loan, they usually come out smaller.

To sum up

A prepayment is an option if you find yourself in a financial position to do so. Personal loan prepayment is beneficial since it allows you to eliminate debt sooner.

Prepayment of any amount on a personal loan has a good effect on credit scores, so even a small amount can help if you can’t pay it off in full.

To lessen the financial pinch of paying interest during the initial lock-in period of a personal loan, you may want to extend the loan’s repayment term. The aforementioned advantages are only yours to reap, however, if you prepay the debt. Think about getting a personal loan from Piramal Finance, where you may get low rates and flexible payback terms.