Is Foreclosure Charge Applicable on Personal Loan & How it Works?
Personal loans are becoming very popular among individuals. This help to meet immediate fund requirements. These can be used for several requirements. These could be investments in business, temporary cash flow mismatches, weddings, medical purposes, travel purposes, emergency expenses, etc. There is no restriction on the purpose for which the loan will be used. No questions are asked by any banks.
Banks offer personal loans with no security at very attractive interest rates.
What is a personal loan, and why would one take it?
A personal loan is a form of unsecured loan banks offer to individuals. The benefits of availing of a personal loan are detailed below:
- No Security: Personal loans are collateral free. One does not have to offer any security for availing of a personal loan.
- Easy application process: Generally, the loan application to disbursement is not a very time taking process. Lenders have now started giving personal loans with minimum documentation. They mostly ask for identity documents and income proofs with a few bank-specific forms to be filled in the lender’s formats.
- Easy Disbursements: The loan is disbursed in one go once it gets sanctioned. The amount is directly credited to the borrower’s savings account once the documentation process is completed.
- Ease of repayment: Personal loans usually have to be paid in EMIs. These are fixed payments that are a fixed amount to be repaid every month. This fixed amount includes both principal and interest. Depending on comfort, one can choose the number of EMIs over which one wants to repay the personal loan.
- No end-user requirements: The lenders never ask for the end use of funds. One is free to put the funds to any use or purpose.
The process of availing of a personal loan is very simplified. One can approach any bank/ multiple banks with the requirements for availing a personal loan with all documents such as identity proof, income proof etc.
After screening the application, the bank undertakes the credit appraisal process internally. Then the loan is sanctioned. Once this is sanctioned, the lender can share the loan documents for execution. After this, the loan amount is credited to the borrower’s account.
Personal loans come with various advantages. But it’s important to note that the borrower should be very careful with the repayments. Never forget to miss any EMI. Doing so would otherwise affect their credit score.
Many lenders have now started offering personal loans with low/nil processing fees.
In this article, we will discuss if foreclosure charges apply to personal loans and how they work.
What are foreclosure charges?
A bank sanctions personal loans for a specified period, as per the borrower’s requirements. If one wants to pay off the loan before the expiry of the tenor for which the loan was sanctioned, it is referred to as Prepayment or Foreclosure of a Personal Loan.
The prepayment of the loan has to be done in one single payment. The lenders allow their customers to prepay a loan. But the prepayment of a personal loan would generally attract foreclosure charges.
Foreclosure charges are like a penalty the lender charges for prepaying the loan.
The foreclosure charges vary across lenders as per their internal policy. The average range of foreclosure charges is between 1% to 5% of outstanding principal. The same is further subject to tax.
In other words, the foreclosure charge will be levied on the outstanding principal on the date of prepayment. Some lenders have different foreclosure rates for different periods. Foreclosure charge may be stipulated as 1% if the remaining tenor of the personal loan is more than 4 years, 2% if the remaining tenor is 2-4 years and 3% if the tenor is 0-2 years etc.
The applicable foreclosure charge on the borrower’s loan will depend on the lender. It will be written on the sanction letter or terms and condition document they receive from the lender. The lenders charge foreclosure charges to compensate for the interest income the customer would otherwise pay.
Benefits of foreclosure of personal loans
- Reduced cash outflows and interest burden
The key advantage of paying off the loan is no cash outflows on account of interest payments. As is said, money saved is money earned! Once they foreclose the loan, the borrower would have paid the principal outstanding. The interest burden gets over.
It’s important to note that some lenders specify a lock-in period in the sanction letter. The lock-in period refers to a period from the date of disbursement of the loan when the borrower cannot foreclose the loan. It’s essential to read the documents carefully to be aware of all the conditions of the personal loan.
However, it is always better to pay off the loan if one has extra cash to save oneself from the interest burden.
- Low debt levels
The borrower can partially or fully foreclose the loan. In both scenarios, one will have to pay foreclosure charges. But it’s important to note that one is freed from the EMI burdens every month.
Whenever one has extra earnings or cash, always try to reduce the debt burdens. While this attracts foreclosure charges, one will still save money on the extra interest one would have paid anyway.
- Improved credit score
All lenders maintain a database of Individuals and their credit profiles. The borrower’s credit score is linked to various factors such as outstanding loans, timely payment of EMIs etc.
Once they foreclose a loan, their credit score improves. This would improve credibility. The borrower would also have a better chance of taking another loan.
It is always advised to opt for a loan with a lower foreclosure charge. One should always compare the foreclosure charges and interest rates, in case one has multiple loan offers.
Final thoughts
In case, the borrower wants to repay the loan, it will help them to save the interest they would otherwise pay for the entire loan tenure. One should compare the applicable foreclosure charges. He should also read the sanction letter or terms and conditions carefully before deciding.
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