What are the prepayment charges on a business loan?
When you are under heavy financial debt, it seems reasonable to get done with your business loan as soon as you can. However, these come with certain penalties. The lenders give out the loans for a certain tenure, thinking about the business loan rates and how much they would benefit from it. A loan prepayment would disrupt their income flow. So, they try to make up for this loss of income by charging you prepayment fees.
Even though the business loan rates may be fixed, you will gain a certain amount of money post-prepayment. This is because if you pay before the tenure, the charge is not going to amount to the total interest for a few years. It may also give you extra flexibility and stabilize your cash flows in the future. Usually, the prepayment charges vary from 2% to 5%. This may depend on the lender. Read more below.
How is the prepayment charge calculated?
Businesses usually plan to repay their loans when they have huge cash inflows without worrying much about the prepayment charges. The prepayment charge is not calculated on the down payment or the amount repaid. It is calculated on the loan amount outstanding. In the case of SME loans, the prepayment charge will vary from lender to lender.
In most cases, the lenders set up a lock-in period in which you cannot repay your business loan. For example, if your loan has a complete tenure of 10 years with a lock-in period of 3 years, you cannot repay it until the three years are over.
How Much Are the Prepayment Fees?
If you are repaying your loan in full at once, you will be charged around 4% of the outstanding loan amount and the principal repaid in the past 12 months as EMI. However, these charges will mostly be less than the interest you will have to pay for the rest of the loan tenure.
If you are paying a maximum of 25% of the outstanding amount of your business financing, you will not have to pay any prepayment charge. However, you would have to pay the GST charges on it.
When Should You Prepay Your Loan?
Apart from the worry of prepayment charges on your business loan, you have to evaluate the cash flows that your business would require at the moment before you decide to repay your loan. For instance, if your business is of a fluctuating sales nature, like a restaurant or a bookstore, you have to keep money ready in case of uncertain events. If you have a business that has a stable nature, then you can repay your loan on time.
Another instance where you can consider repaying your loan before the due date is when your business has become a lot more successful than when you took the business financing. This would imply that you have had a lot of cash inflows and have enough of it to repay your loan and free yourself from all debts. This will also have a positive impact on your existing credit score.
When Should You Not Prepay Your Loan?
It would not make sense to try to repay your business loan before time if you have not fulfilled the purpose that you took the loan for. If your business has not gained the stability you expected, you should not opt for the prepayment option. It would be wise to focus on the growth of your business and then repay your loan. If you are worried about your credit score, timely payment will not affect it negatively.
Interests on a business loan are tax-deductible under the Income Tax Act. If you opt to repay your loan before time, you will lose all the tax benefits that you could have gained. The worst thing that could happen will be that your business will move to a higher tax bracket than it already was.
Will The Remaining Interest Be Waived?
If you choose to close your business loan before time, you will be free from all the remaining interest payments. This is one of the main reasons why people opt to prepay their loans despite having prepayment charges to pay.
Key Takeaways
Getting a loan for business financing is a good option, but read the terms and conditions properly. Take a close look at the lock-in period and the prepayment options and charges that will be levied. Even though the terms of repayment are flexible, calculate the prepayment charges before deciding to prepay it.
The documents required for the prepayment of a loan are the loan documents, identification proof, and bank statement that shows the principal and interest repayment. Also, the proof that shows the approval of the lender for prepayment is important.