What is prepayment penalty on personal loan and how to get avoid it?

A personal loan is the most famous financial product ever created. If you have taken a personal loan, you will relate to the headache of EMIs. While the EMIs take a lot of load from your head, missing an EMI robs you of the night’s sleep. Nobody likes to pay an EMI, and people try to avoid it if they can. 

Most people take a loan if they are financially struggling. And once their condition improves, they try to repay the loan as soon as possible. However, banks prefer to avoid early payments on personal loans. So, most banks levy a prepayment penalty if you try to pay off the personal loan. 

So, let’s see what is a prepayment penalty on a personal loan and how to avoid it. 

What is a prepayment penalty on a personal loan?

Though it may seem a little odd, why should you pay the penalty for paying the loan early? Banks do so to discourage you as they get a more extended period of interest on EMI. You can either make a full prepayment or pay it in parts. 

If you read the loan agreement, you will find banks mentioning they will charge you a percentage of the total loan amount if you close the loan early. This charge varies for each financial institution. Typically, banks waive the prepayment charges if you have paid more than 12 EMIs.

The RBI circular on prepayment penalties says “banks shall not charge the prepayment fines on any floating rate term loan.” However, it doesn’t apply to personal loans as it comes under fixed-rate term loans. 

Pros and Cons of Paying off a personal loan early: 

Pros: 

• Saving on Interest : 

The interest rate for a personal loan is relatively higher, so a considerable part of savings goes to waste as EMI. For example, if you have taken a loan for 5 years, but your financial condition improves in the 4th year. Now you can close the loan early and save the interest. In this case, the bank loses one year of interest, so there is a prepayment penalty. 

• Increases the chances of getting a new loan: 

Banks and NBFCs prefer to lend to those whose total EMI is not more than 50% of their monthly salary. The bank may reject your loan application if you are paying an EMI and applying for another loan. 

So, it’s essential to reduce the EMI/NMI (net monthly income) to under 50-60% if you want a new loan. Paying your personal loan early can increase the chances of getting approved for another loan. 

• Reduces the percentage of Unsecured loans in the credit mix: 

A credit mix is defined as the promotion of total secured and unsecured loans. As we know, a personal loan is an unsecured loan, and you can lower the percentage by paying it early. Credit rating companies give higher credit scores to people with a diversified portfolio. 

• Increases CIBIL score: 

Paying the personal loan early can also increase your CIBIL score. It’s because closing a loan fully and early acts as an excellent booster for credit score. A clean and high CIBIL score can help you obtain a loan quickly and with a much better term. 

Cons: 

• Requires a large payment: 

Closing a loan early has its advantages; however, you will require to make a significant payment. This can affect your financial condition temporarily. 

• Impacts liquidity negatively: 

Closing a loan early requires a considerable sum of money. Doing so sometimes requires breaking up other investments. This may cost severely in case of any medical or financial emergency. So, consider paying off your loan early if you have additional savings. 

We have seen the pros and cons of closing the personal loan early. Let’s see how you get rid of the prepayment penalty.

How to get rid of the prepayment penalty: 

As we know, banks charge a prepayment penalty to discourage you from closing the loan early. There is no easy way to get away from the prepayment penalty. It’s because once the loan agreement is signed, you can’t do much on this front. 

Let’s talk about the options you have in the case of a prepayment penalty. 

• Read the fine print: 

This is the most important and wise thing you can do before signing the loan agreement. At the same time, some banks don’t charge a prepayment fee, most charge, and some financial institutions don’t come clean regarding this.

Details like foreclosure penalties are often mentioned in the fine print, which rarely anyone bothers to read. So, if you want to get away from prepayment penalties, don’t apply for a personal loan from these banks. 

• Negotiate better: 

If you have a better CIBIL score, use it for your benefit. With a better CIBIL score, you can negotiate better with the lender on the loan terms. You can ask for a better interest rate and a loan free of prepayment penalty. 

Most banks have a limit of 12 EMIs, after which you can close the loan early. Some banks also don’t charge a foreclosure fee if you pay the loan after a specific time. 

Conclusion 

Closing a debt early is a good idea as it saves you some money on interest. While the prepayment fine may seem like an issue, it isn’t much of a concern. As per the industry norms, foreclosing a debt is always a better option than giving EMIs for the entire term. 

When you prepay a loan in whole or in partial payment, it lowers the interest on the outstanding amount. This helps save a significant amount of money as the EMI gets lower. 

Moreover, closing the personal loan early affects your CIBIL positively, and steers clear from existing loans. So, closing the personal loan early is a good idea even after paying the prepayment penalty.

You can use the EMI calculator of Piramal Finance to know your EMI before applying for a loan. 

You can also apply for a personal loan from Piramal Finance at an attractive interest rate. 

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