Credit options such as Business Loan, Personal Loan, Home Loan, etc. help people meet their urgent financial needs. Although the interest rates are competitive, you can save extra by going for options like prepayment, part-payment, or pre-closure. These terms might sound similar at first but there are some prominent differences between them. Read on to understand the key differences between prepayment and part payment.
First, let’s understand the part payment meaning. The part-payment of a loan happens when the borrower has some idle money, not equal to the entire outstanding principal amount. The borrower deposits this amount in the loan account to reduce the outstanding debt. As a result, the EMIs and the total interest you pay are reduced. However, it is vital to note that you can benefit from this repayment schedule only when you spend a significant amount of lump sum money as part of the payment.
The part-payment amount is deducted from the principal outstanding when you make the partial payment. After minimising your interest outgo, the savings you earn depend on the timing and amount of the part payment. It is not good to make a small part payment, especially if the financial institution charges you extra for prepayment.
Part-payment of a Personal Loan has another advantage. You can make a part payment several times, depending on your capability. Some borrowers make a partial payment more than once, while others make a regular payment of a lump sum amount. Part-payment will reduce your EMI amounts, and total interest paid irrespective of the payment frequency.
If your bank or financial institution levies prepayment charges on every transaction, you can still benefit by paying back a substantial amount regularly. The interest you save on the whole will be much more. The only drawback in part-payment is that banks may not permit you to do so on specific types of loans. They set a lock-in period on the term and the part payment amount.
Prepayment is a facility that lets you repay the loan in part or full, before the end of the loan tenure. Most banks allow you to prepay the outstanding principal amount after one year. This repayment schedule helps you save a lot on interest. Let us understand this with the help of an example.
Ajay takes a loan of ?3 Lakh for five years at an interest rate of 15% per annum. His equated monthly instalments are ?7,137. He pays an interest of ?35,529 in the first year. The outstanding principal amount after the first year is ?2,64,160. On prepaying the outstanding amount, he saves interest of ?57,049.
The prepayment option lets you save on interest and get out of debt early. Moreover, the bank or the lender may reward you if you prepay your Personal Loan. For instance, banks provide value-added services like a free trading account or a zero-balance savings account to borrowers who choose prepayment.
However, some banks impose a penalty of 2% to 5% for loan foreclosure. This fee is charged on the outstanding principal amount. You can better understand the figures by using an online EMI calculator. The calculator estimates the cost of the loan and your savings with the prepayment facility. Just fill in the loan amount, interest rate, tenure, processing fee, method of prepayment, and foreclosure charges to get the required results.
The Reserve Bank of India (RBI) has recently instructed banks not to charge any penalty on the pre-closure of loans. However, the amendment is restricted to loans taken on a floating rate only. Personal Loans are generally on a fixed interest rate, and therefore, the rule does not apply.
Pre-closure or foreclosure of a loan refers to repaying the outstanding principal amount in a single instalment before the end of the loan term. The legal process helps in reducing interest liability significantly. Moreover, it aids in closing the loan account well before its tenure.
To foreclose or pre-close a loan, the borrower must apply to the respective lending institution or bank. The lender will calculate the foreclosure balance after considering the total outstanding obligations, the remaining term of the loan, and the interest paid. If the calculations and the amount are satisfactory, you can pay off the amount and close the loan.
Depending on the lender's terms, a Personal Loan usually has a one-year lock-in period. You can prepay the balance and settle the loan account after this time. Ensure you collect the “No-dues” certificate and original documents from the bank or lending institution after settlement.
In some instances, the bank or the lender forecloses the loan. The situation arises when the borrower cannot repay the loan amount and defaults on EMI. The lender auctions the borrower's collateral. After the amount equivalent to the outstanding loan amount is raised, the lender forecloses the loan account.
The option of pre-closing a loan has been beneficial for multiple borrowers, however, it has its disadvantages as well.
Following are some of the benefits of preclosing a loan:
1. Increased Affordability of EMIs
Banks offer applicants a loan with maximum monthly instalments of up to 60% of their income per month. This 60% mark includes all your active loans and EMIs, thus, you will not get a loan beyond that. So pre-closing a loan will help you in reducing the monthly instalment ratio as per your monthly income. This eventually would make you eligible to take more loans.
2. Reduce Interest Cost
Borrowers can save huge interest costs by pre-closing their loans. In simple words, if you take a loan of ?5 Lakh at 13% per annum with a 5 year tenure for repayment, then your ?11,377 and ?1.83 Lakh will be your total interest. However, pre-closing this loan after one year would save you up to ?1.22 Lakh of interest cost.
The drawbacks of foreclosing a loan are as follows:
1. Reduces Monetary Liquidity
People often use their investments or liquidate their assets for pre-closing their loans. This affects their emergency fund balance and makes them risk-prone. For example, using your assets or investment to pay off your loan to save interest costs could create issues in case of a medical emergency, unemployment, etc. Thus, it would be prudent to only pre-close your loan, if you have sufficient funds. Or else you will be forced to take another personal loan at a higher interest rate to meet your emergency fund requirement.
2. Pre-Closing Loan Charges
Pre-closing your loan doesn’t favour banks, as they lose money because you pay a lower interest. Thus, most banks have pre-closure charges on your outstanding loan amount. Thus, before pre-closing a loan, calculate your net savings by comparing the pre-closing charges with the interest due to be paid on your loan.
ALSO READ :- What are Foreclosure Charges on Personal Loan?
Refer to the below chart to understand the differences between part-payment, pre-payment and pre-closing of your loan:
Part-Payment of Loan
Prepayment of Loan
Pre-Closure of A Loan
Reduces your principal amount
Reduces your principal amount
Full loan repayment
The rate of interest remains the same.
Rate of interest will reduce.
Rate of interest remains the same.
EMI will reduce
EMI will reduce
When you make a part payment against your loan, it has a negligible effect on your CIBIL Score. It reduces the total loan amount and the interest, making it easier for you to clear the loan on time. However, prepayment and foreclosure have a positive impact on your credit score.
Many lenders are offering attractive loan options. However, borrowers do not want to be debt-ridden. They want to repay the loan at the earliest. Prepayment and foreclosure facilities allow them to get rid of the debt earlier and save on interest. When they invest their surplus money in their loan account, they reduce the outstanding loan amount, thereby lowering the EMI or the loan tenure.
Apply for a loan with suitable terms and conditions at Poonawalla Fincorp and cover your emergency monetary needs.
The term prepayment is used when a borrower prepays part of the loan before the end of the term, whereas the term foreclosure is used when a borrower repays the entire loan before the end of the tenure.
In banking, pre-closure occurs when a borrower prepays the loan amount before the completion of the loan tenure.
By using the part payment method, a borrower can reduce his/her monthly EMIs, and total interest paid. In the case of prepayment, the borrower pays off the entire loan amount (principal + interest) and closes the loan.
No, a foreclosure of your Loan doesn’t affect your CIBIL score. However, if you are still building your credit score as a new or inexperienced borrower, then it makes sense to continue repaying for the entire loan duration.
A part prepayment can result in reduced tenure or a reduction in your EMI amount.
We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Loan disbursal is at the sole discretion of Poonawalla Fincorp.
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