Loan prepayment, part-payment, and loan pre-closure (loan foreclosure) are repayment options that help borrowers reduce their loan burden before the tenure ends. While all three can lower the overall interest outgo, each works differently and uniquely affects the loan. Hence, when it comes to part payment vs prepayment vs preclosure, understanding the differences can help borrowers make an informed repayment decision by choosing the most suitable option.
What is Part-Payment of a Loan?
A part payment is when you pay off a portion of the principal balance of your loan before your scheduled EMI. If you have surplus funds available, you may make a one-time payment and deposit this amount into your loan account. The part-payment amount is deducted directly from your loan's outstanding principal. This reduces the total interest payable over your loan.
How Part-Payment Helps Reduce Interest Burden?
When you make a part payment on your loan, the lender recalculates your principal amount owed, thereby providing you with options for a lower EMI amount or a reduced tenure, subject to terms and conditions. You need to determine which option best fits you when you make this part payment.
Therefore, before making a part payment on your loan, it is important to read the loan agreement properly. Check for any lock-in periods and minimum part payment amounts established by the lender. A small part-payment is not advisable if the lender charges a fee per transaction.
Advantages of Part-Payment
Part-payment offers the following benefits:
- You can make part-payment on your loan multiple times during its term, depending on the lender’s policies.
- Each part-payment reduces your principal balance, which helps to reduce your EMI and your overall interest costs.
- Even if there are part-payment fees charged, when you make a large payment, you usually save interest in the long run.
- Not all lenders allow part-payments for all types of loans; hence, you need to check with your lender for their terms before proceeding.
What is Loan Prepayment?
Loan prepayment means repaying your loan before the end of the loan term. You can choose to prepay your loan in part or in full before the end of the loan tenure. Prepayment charges, if applicable, vary depending on the lender, loan type, and interest rate structure. Hence, borrowers should understand the terms, costs, and repayment conditions of a loan before making financial decisions.
Advantages of Loan Prepayment
Loan prepayment offers the following benefits:
- Prepaying your loan decreases your outstanding principal amount.
- It causes a shorter loan term and relieves you of debt faster.
- It reduces your debt-to-income ratio, which improves your credit score.
- Many lenders provide additional benefits for borrowers who prepay their loans, such as a free trading account or a zero-balance savings account.
- If you have a large amount of surplus funds from a bonus, an inheritance, or a matured investment, prepayment could save you a lot of money.
What is Loan Pre-Closure?
Pre-closure or foreclosure is defined as the complete payment of a loan in one lump sum before the actual loan term ends. The difference between pre-closure and prepayment is that when you pre-close a loan, you pay off the entire principal amount in one payment. Loan pre-closure can only occur after the lender’s stated lock-in period in your loan agreement.
Advantages of Pre-Closure
When you pre-close your loan, you enjoy the following advantages:
- Lower interest expense: As an indicated example, if you pre-close your ₹5 Lakh loan at 13% per annum after one year, you have saved about ₹1.22 Lakh.
- Improved loan eligibility: Paying off your loan reduces your EMI-to-income ratio, which may allow lenders to offer you a higher loan amount in the future, subject to your creditworthiness and repayment capacity.
- Positive impact on credit: Paying off your total loan shows lenders that you are responsible with your finances, and this helps improve your credit scores.
Disadvantages of Pre-Closure
Although pre-closing a loan provides benefits, there are some limitations to pre-closing:
- Reduced liquidity: By using some of your savings to pre-close your loan, you may have less money available for emergencies.
- Pre-closure charges: Most lenders charge between 2% and 5% of the remaining amount on your loan.
Pre-closing a loan should generally be considered only if the interest savings exceed the applicable pre-closure charges.
Part Payment vs Prepayment vs Pre-closure: Key Differences
The table below summarises the difference between part-payment, loan prepayment, and pre-closure (loan foreclosure).
|
Parameter |
Part-Payment |
Prepayment |
Pre-Closure |
|
Principal Amount |
Reduces the outstanding principal amount partially. |
Partially or fully reduces the outstanding principal. |
The entire outstanding principal amount is repaid in one go. |
|
Interest Rate |
No change, total interest outgo reduced |
No change, substantial reduction in total interest paid. |
The interest rate ceases to exist. |
|
EMI |
The amount of EMI or the time period to repay the loan decreased. |
The amount of EMI or the time period to repay the loan reduces. |
Once the entire loan is repaid, no further EMIs are payable. |
|
Loan Status |
The outstanding balance on the loan only reduced; the loan still exists. |
The balance remains unless the loan has been prepaid. |
The total loan has been paid; there are no remaining obligations under the loan agreement. |
|
Charges |
Fees to make a part payment may vary depending on the lender. |
The prepayment fee is set by the lender. Charges for floating-rate loans are prohibited by the R.B.I. |
Typically charged at 2%-5% on the outstanding loan amount in a pre-closed scenario. |
|
Frequency |
You can make part-payments multiple times during loan repayment. |
You can prepay once or multiple times to reduce the outstanding principal. |
Done once; paying off the entire loan closes the account. |
Each loan repayment option suits a different financial situation.
Read Also: Mastering Loan EMI Payments: Strategies for Timely and Convenient Repayments
Effect of Loan Prepayment on Your Credit Score
Loan Prepayment has an effect on credit score:
- Part-Payment of your loan reduces the amount of the loan outstanding.
- Loan prepayment and pre-closure have a positive effect on your credit score. They demonstrate to credit bureaus that you are a responsible financial consumer.
- For new borrowers still building their credit, maintaining a consistent loan repayment record across the full tenure is equally beneficial.
Whether through regular EMI payments or by making prepayments or foreclosing the loan, maintaining a strong repayment record can help improve your credit score over time. According to the credit bureau CIBIL, repayment history is one of the key factors considered in credit score calculations.
To Conclude
To effectively manage your loan repayments, you must understand the difference between part payment, loan prepayment, and loan pre-closure. Each option helps reduce the outstanding principal and save on interest. You can choose to prepay your loan, make part-payments, or pay off the entire loan, depending on your financial position. Also, it's important to always refer to your loan agreement to know about charges and lock-in periods.
FAQs
Is part-payment better than reducing the loan tenure?
Reducing the loan tenure usually results in higher interest savings compared to lowering the EMI. A shorter repayment period reduces the total interest payable over the life of the loan.
Can I make a part-payment or prepayment through online banking?
Many lenders allow part-payments and pre-payments through their online banking portal or mobile application. Check with your lender for the available options and process.
Does a loan lock-in period apply to all types of loans?
The lock-in period depends on the lenders as well as the nature of the loan. Loans that allow pre-payment may also come with some restrictions about when it can be done.
Can I make multiple part-payments during my loan tenure?
Many lenders allow borrowers to make multiple part-payments during the loan tenure. However, the frequency and amount may be subject to the lender's terms and conditions.
What documents should I collect after pre-closing a loan?
You should get a No Dues Certificate, proof of loan closure, and any original documents that the lender holds.
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.
*Terms and Conditions apply