Personal loans are considered to be one of the quickest and easiest loan options for those with urgent fund needs. While the interest rate can be relatively higher, there are no restrictions on end use. However, with a general inhibition of indebtedness, borrowers often seek to prepay their loan with excess funds when available. Note that opting for prepay personal loans can always be an optimal option.
If you are one of those people considering the partial or pre-payment of personal loans that you took out during the crisis and cash need, Gaurav Aggarwal, Director of Unsecured Loans at Paisabazaar.com, shares a list of the top six factors That You Should Consider Before Deciding To Prepare For Personal Loans. Customers must consider these points before proceeding to the personal loan prepayment option: –
1- Prepayment / Foreclosure Fees
Because the RBI has excluded lenders from penalizing prepayment of personal loans at floating rates, there are no prepayment fees for personal loans that are available at floating rates. On the contrary, personal loans that are available at fixed rates incur prepayment fees, which can be as high as 5% of the principal’s outstanding capital base.
Note that most lenders who offer fixed-rate loans do not allow partial prepayment of personal loans. In addition, few lenders do not allow partial prepayment before borrowers pay back a predetermined number of credit EMIs.
2-interest savings
The reason for opting for a prepayment loan is to save on interest costs. However, there is a widespread misconception that only prepayments in the early stages of the loan can save interest costs and not in later stages of the loan term. In reality, interest savings can also be achieved in later phases. Use the online prepayment calculator for personal loans to determine the interest savings on prepayment. Only select this option if you can save a significant amount after considering any prepayment fees.
3-Impact on the Emergency Fund
Ideally, your emergency fund should be sufficient to cover your mandatory monthly costs for at least 6 months. These expenses should include your insurance premiums, living expenses, credit EMIs, home rent, electricity bills, child fees, etc. However, many personal borrowers use their emergency fund allocations to prepay their personal loans in order to lower their interest costs. This can have a massive impact on your financial health as in the event of a financial need or loss of income due to illness, disability, job loss, etc. you will either have to repay your long-term investments or borrow at a higher interest rate.
4-return on existing investments
Potential returns on existing investments such as time deposits, mutual funds, insurance policies, etc. should also be considered when deciding whether to prepay loans. Avoid paying back high yield investments or investments that are expected to generate higher returns compared to the interest rate on your personal loan.
Low-interest investments in short-term debt, time deposits, etc. that are not tied to a critical financial objective can be liquidated to prepay your personal loans as the returns generated by these instruments are generally lower than the interest rate charged on personal loans .
5-opportunity cost of not investing
In the context of prepayments, opportunity cost is the missed opportunity to generate higher returns by channeling excess funds towards prepaying loans rather than investing. In other words, it is the difference between the return on your investment that you forego for prepaying loans and the savings on interest costs that comes with prepayments.
The non-investment opportunity cost for stocks and shares is significantly higher during the bearish market phase or during strong market corrections if they can be drawn at attractive valuations. The returns generated by equity investments under market conditions can be significantly higher than the interest savings costs of prepayments for personal loans.
6-New loan application
Loan applicants are preferred by most lenders with an EMI to Net Monthly Income (NMI) ratio of 50%. This includes EMIs of the existing loan as well as the new loan. Existing personal borrowers who are planning to take out another loan, such as a home loan or a car loan, and who exceed their EMI / NMI ratio can therefore improve their credit prospects by prepaying their personal loan. thereby lowering their EMI / NMI ratio.
