How Pre-closure of Personal Loan Can Impact Your Credit Score

Managing your finances wisely includes repaying your loans on time and, in some cases, repaying them early. Pre-closure of a Personal Loan, also known as foreclosure, refers to repaying your outstanding loan amount in full before the end of the loan tenure. While it might sound like a good financial move, it’s essential to understand how pre-closure affects your credit score.
In this blog, we will explore what Personal Loan foreclosure means, its pros and cons, and most importantly, how it impacts your credit score in the short and long term.

What is Personal Loan Pre-closure? 

When you decide to pay off the remaining loan balance in one go, before the scheduled end of the loan tenure, it is termed as a pre-closure or foreclosure of the loan. This is done to reduce interest payments or to become debt-free sooner.

Benefits of Pre-closing a Personal Loan

Here are some benefits of pre-closing a loan for personal use:

1. Reduced Interest Burden
The biggest advantage of early repayment is saving on interest. As personal loans carry higher interest rates (as compared to secured loans), pre-closing them reduces your overall borrowing cost.

2. Improved Debt-to-Income Ratio
Clearing off a loan early improves your monthly cash flow and reduces your debt obligations, which in turn strengthens your debt-to-income ratio.

3. Financial Freedom
Paying off a loan early can bring peace of mind, reduce financial stress, and give you more flexibility in managing your finances.

How Pre-closure Affects Your Credit Score

Let’s understand how loan pre-closure affects your credit score:

1.    Debt Reduction: Paying off a loan early lowers your overall debt burden, potentially improves your credit score.
2.    Shorter Credit History: If the loan was one of your few credit accounts, closing it early may shorten your credit history, slightly impacting your score.
3.    Payment History: Regular EMI payments build a strong credit profile. Pre-closure means you might lose out on a longer track record of positive payments.
4.    Pre-closure Charges: Some lenders impose penalties for early repayment, which could reduce the financial benefit of closing the loan early.
5.    Credit Mix Impact: If the loan is your only form of credit, closing it might affect your credit diversity, which is a factor in credit scoring. 

Factors to Consider Before Pre-Closure

Before you rush to close your loan early, keep the following points in mind:

a) Foreclosure Charges
Some lenders impose pre-closure penalties of certain percentage of the outstanding loan amount. Compare the interest savings vs. the penalty to ensure it’s worth it.

b) Credit Mix Impact
A healthy credit mix includes both secured and unsecured loans. If you pre-close your only unsecured loan, it may slightly affect your credit score due to a narrower credit mix.

c) Loan Tenure & Interest Stage
If you're nearing the end of your loan tenure, you’ve already paid most of the interest. In such cases, pre-closure may not offer much financial benefit.

d) Other Financial Goals
Ensure that the money used for pre-closure isn’t cutting into your emergency fund, investment plans, or other financial goals.

Best Practices for a Positive Credit Score After Pre-closure

Check out some best practices for positive credit score after pre-closure:
1. Get a No-dues Certificate (NOC): Always ask for written confirmation from your lender that the loan has been fully repaid.
2. Check Credit Report: After 30–60 days of pre-closure, check your credit report to ensure the loan is marked as “Closed” and not “Settled.”
3. Avoid Too Many Pre-closures: If you habitually pre-close loans, lenders might view it as unpredictable behaviour. Space out pre-closures if you have multiple loans.
4. Continue Using Other Credit Responsibly: Keep using your credit card or other loans with regular repayments to maintain a healthy credit activity.

When Does Pre-closure Make Sense

Pre-closing your Personal Loan is a smart move:
•    When you receive a lump sum (bonus, inheritance, maturity of investment).
•    When you want to reduce monthly liabilities.
•    When you’re aiming for a bigger loan and want to improve eligibility.

To Conclude

Pre-closing a Personal Loan is a financially empowering decision when planned wisely. While it might cause a small and temporary drop in your credit score, the long-term impact is usually positive. It improves your overall financial health, reduces your debt burden, and reflects your creditworthiness, provided it’s reported correctly to credit bureaus.
Always balance your decision between saving on interest and maintaining a healthy credit profile. When in doubt, consult your lender to understand how pre-closure aligns with your financial goals.

Frequently Asked Questions

1.    What are the benefits of pre-closing a Personal Loan?
The primary benefit is saving on interest costs. It also improves your debt-to-income ratio, making you eligible for future loans.

2.    Can pre-closure negatively impact my credit score?
If pre-closure shortens your credit history or reduces opportunities for positive credit behaviour, it may have a slightly negative impact.

3.    How does pre-closure affect my credit mix?
If you don’t have other active loans, pre-closure may impact on your credit mix, which is a factor in your credit score.