Wanted money during crisis? Took personal loan? Thinking of pre-payment? Wait! First read this for big benefits

Personal loan is considered as one of the quickest and simplest loan option for those having urgent fund requirement. While its rate of interest may be relatively higher, there are no restrictions on the end usage. However, considering a general inhibition towards debt, borrowers often try to prepay their loan with surplus funds, whenever available. Note that, opting for personal loan prepayments may be an optimum option all the time.

If you are one of those considering the part payment or pre-payment of personal loan you availed during the hour of crisis and money need, Gaurav Aggarwal, Director, Unsecured Loans, Paisabazaar.com shares a list of top 6 factors to consider before opting for personal loan prepayment.Borrowers must keep in mind these points before going ahead with loan prepayment option available on personal loans:-

1- Prepayment/foreclosure charges

As RBI has debarred lenders from penalizing prepayment of retail loan at floating interest rates, personal loan available at floating rate does not attract prepayment charges. On the contrary, personal loan available at fixed rates incur prepayment charges that can go as high as 5% of the principal outstanding basis the lender.

Note that most of the lenders offering loan at fixed rates does not allow part prepayment of personal loan. In addition to this, few lenders does not allow part prepayment before borrowers repay a predetermined number of loan EMIs.

2-Interest savings

The reason behind opting for loan prepayment is to save on interest cost. However, there exists a widely held misbelief that only prepayments made in starting stages of loan can result in interest cost savings, and not in later stages of loan tenure. In reality, interest savings can be made in later stages as well. Take the assistance of online personal loan prepayment calculators to know the interest savings on prepayment. Choose this option only if you are able to save a considerable amount after factoring in prepayment charges, if any.

3-Impact on emergency fund

Ideally, your emergency fund should be adequate enough to meet your monthly mandatory expenses of at least 6 months. These expenses should include your insurance premiums, living expenses, loan EMIs, home rent, utility bill, children’s tuition fee etc. However, many personal loan borrowers tend to use their allocations specifically meant for emergency funds for prepaying their personal loans to reduce their interest cost. Doing so can massively hamper your financial health as in case of any financial exigency or loss of income owing to illness, disability, job loss etc will impel you to either redeem your long term investments or take up loans at a higher rate of interest.

4-Returns from the existing investments

Potential returns from existing investments such as fixed deposits, mutual funds, insurance policies etc should also be considered when deciding about loan prepayment. Avoid redeeming high yield investments or any investments that are expected to yield higher returns as compared to interest rate charged on your personal loan.
Low yield investments in short term debt funds, fixed deposits etc not linked to any crucial financial goal can be liquidated for prepaying your personal loans as the returns yielded by those instruments are generally lower than the rate of interest levied on personal loans.

5-Opportunity cost of not investing

In context to prepayments, opportunity cost is the lost opportunity of availing higher returns by routing surplus funds for loan prepayment, instead of investing. In other words, it is the difference between returns on your investment that you forgo for making loan prepayments and savings in interest cost generated on prepayments.

The opportunity cost of failing to invest is considerably higher for equity and stocks during bearish market phase or steep market corrections, when they can be availed at attractive valuations. Returns generated via equity investing in the course of market conditions can be considerably higher than savings interest cost on personal loan prepayments.

6-New loan application

Preference to loan applicants are given with an EMI to Net Monthly income (NMI) ratio of 50% by most lenders. This includes EMIs of the existing loan as well as for the new loan. Hence, existing personal loan borrowers planning to take up another loan, say home loan or car loan and are exceeding their EMI/NMI ratio can enhance their loan eligibility chances by prepaying their personal loan; thereby lowering their EMI/NMI ratio.