Difference Between Part-payment, Pre-payment, And Pre-closure

Our financial requirements change from time to time, and so do the requirements of credit options such as Business Loan, Personal Loan, Loan Against Property, home loan, etc. These loans are the best options to fulfil your financial goals. However, before you apply, check all the terms and conditions carefully, which include prepayment, part-payment, or pre-closure of your loan. These terms might sound similar at first, but there are some prominent differences between them. Read on to understand the pre-payment and part-prepayment meanings and the key differences between them. Let's get started!

What is Part-payment or Partial Payment in a Loan?

As the name suggests, part-payment means you repay the partly when you have some extra money. This is not equal to the entire outstanding principal amount, but you can deposit 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, depending on your financial situation, as part of the payment.

How Part-payment Works?

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, as it may increase your burden.

Advantages of Part-payment

Here are some advantages of part-payment of a Personal Loan:

• 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 to 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. 

Also Read: A Brief Guide to Personal Loan Part-Prepayment

What is Pre-payment of a Loan?

Pre-payment is a facility that lets you repay the loan in part or in 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 lenders 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.

What is Loan Pre-Closure?

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, especially when the final payment is made. Moreover, it aids in closing the loan account well before its tenure.

How Loan Foreclosure Work?

To foreclose or pre-close a loan, you 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 early. But make sure you check the lender's terms as they can vary from lender to lender. 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 on the loan when the borrower cannot repay the loan amount and defaults on EMI, failing to meet financial obligations. The lender auctions the borrower's collateral. After the amount equivalent to the outstanding loan amount is raised, the lender forecloses the loan account.

Also Read: What is Foreclosure: Overview, Process and How It Works

Advantages and Disadvantages of a Loan Foreclosure

The option of pre-closing a loan has been beneficial for multiple reasons; however, it has its disadvantages as well. 

Advantages of Pre-closing a Loan

Following are some of the benefits of pre-closing a loan:

1.  Increased Affordability of EMIs

Lenders 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 loans in future. 

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 monthly EMI is ₹11,377, and yearly ₹1.83 Lakh will be your total interest. However, pre-closing this loan after one year would save you up to ₹1.22 Lakh on interest compared to paying EMIs for the full 5 years. 

Disadvantages of Pre-closing a Loan

The drawbacks of foreclosing a loan are as follows:

1.  Reduces Monetary Liquidity 

People often use their investments or liquidate their assets to pre-close their loans. This affects their emergency fund balance and makes them risk-prone, especially in dealing with unexpected expenses. 

For example, using your assets or investment to pay off your loan to save interest  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.    Loan Foreclosure Charges

Pre-closing your loan doesn’t favour financial institutions, 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?

Difference between Part-payment, Prepayment, and Pre-closure of a 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
Principle amount	Reduces your principal amount	Reduces your principal amount	Full loan repayment
Interest Rate	The rate of interest remains the same	The rate of interest will reduce	The rate of interest remains the same, but need not be paid as the entire loan balance is paid
EMI	EMI will reduce	EMI will reduce	No EMI

 

Effect of Loan Prepayment on Credit Rating

  When you make a partial 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 and manage your cash flow. However, prepayment and foreclosure have a positive impact on your credit score.

To Conclude

The difference between part payment, pre-payment and pre-closure is essential to understand if you are planning to repay your loan early. Prepayment and foreclosure facilities allow you to get rid of the debt earlier and save on interest. When you invest your surplus money in the loan account, it reduces the outstanding loan amount, thereby lowering the EMI or the loan tenure. 

However, before any early repayment of the entire outstanding  amount, check for the lender's policies, terms and conditions to have a hassle-free loan repayment journey. 

Frequently Asked Questions 

What is the difference between prepayment and foreclosure?

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.

What is pre-closure in banking?

In banking, pre-closure occurs when a borrower prepays the loan amount before the completion of the loan tenure.

What is the difference between prepayment and part payment?

By using the part payment method, a borrower can reduce his/her monthly EMIs through partial prepayment and total interest paid. In the case of prepayment, the borrower pays off the entire loan amount (principal + interest) and closes the loan.

Do foreclosure charges affect your CIBIL score?

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.

Does part prepayment reduce EMI?

A part prepayment can result in reduced tenure or a reduction in your EMI amount.