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.
What is Part-Payment in Loan?
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.
What is Prepayment of a Loan?
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.
What is the Pre-Closure of a Loan?
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.
Advantages and Disadvantages of Pre-Closure of a Loan
The option of pre-closing a loan has been beneficial for multiple borrowers, however, it has its disadvantages as well.
Advantages of Preclosing a Loan
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.
Disadvantages of Preclosing a Loan
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?
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. | Rate of interest will reduce. | Rate of interest remains the same. |
|
EMI | EMI will reduce |
EMI will reduce | No EMI |
Effect of Loan Prepayment on Credit Rating
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.
To Conclude
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.
Frequently Asked Questions About Loan Prepayment
- 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, and total interest paid. In the case of prepayment, the borrower pays off the entire loan amount (principal + interest) and closes the loan.
- Does foreclosure 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.
