In today’s competitive market, consumers need to find ways to save money, including paying off loans. Let us find out if you can prepay your loan without extra charges and see why doing so might be beneficial for you.
Personal Loan Dues
Personal Loans have higher interest rates due to their ease of availability and unsecured nature. You should be aware that interest rates on Personal Loans can go up to 25% per annum. Even if the resulting EMIs fit your budget, the interest expense may be too high. EMI stands for Equated Monthly Instalment- fixed payments that a borrower makes monthly to repay a loan.
A collateral free personal loan can help you reduce interest payments. Prepayment can be done either in whole or in part. A fee is associated with it as it cuts the interest revenue of the loan provider. Loan fees typically range from 2% to 5% of the principal balance, plus 18% GST. Several financial institutions like Poonawalla Fincorp will help you save money by not charging you a prepayment fee.
How Does Prepayment Reduce Personal Loan Interest Payout?
Suppose you are paying back a Personal Loan of ₹7 Lakh with an 18% interest rate over five years. In this case, your EMI would have been ₹17,775. If you’ve already paid off the EMI for two out of the five years of your loan tenure, the amount you still owe to the provider would be around ₹4,91,679. Based on how the loan is set up, you must have paid ₹2,18,290 in interest. If you keep going at this rate, you could end up paying ₹3,66,524 in interest on the loan.
If you pay ₹2 Lakh toward your loan, the amount you still owe will go down to ₹2,91,679. Your new EMI will be ₹10,545, and over the next three years, interest will add up to ₹87,937.
If you add up the interest you’ve already paid and the interest you’ll have to pay over the next three years, the total amount you’ll have to pay is estimated to be ₹3,06,227. This is ₹60,297 less than if you didn’t make any part payments. And if there are no extra fees for paying early, you’ll save ₹60,297.
If your provider charges 4% of 2,00,000 plus 18% GST for prepayment, you’ll lose ₹9,440.
As a consequence, you’ll be saving a total of INR 50,857.
The question is how to determine or accumulate the prepayment amount.
Prepayment is preferable due to the advantages it offers. The problem though is determining an amount that would be large enough to matter. Because you might get a small bonus or a sudden influx of profits, the goal should be to accumulate wealth by optimizing cash flow.
For instance, someone who solely considers the bottom line, or your income after expenses are paid off, may find it illogical to lease supplies, equipment, or real estate because doing so typically results in higher costs than owning.
However, you’ll need to keep a cash flow for daily operations unless your business is cash rich. Leasing allows you to make smaller payments over time, which enhances cash flow. An additional benefit is that leasing payments are deductible on your taxes as a business cost.
If you accumulate total money, do you plan to pay it off all at once? It takes a lot of work to come to this answer. If you expect uncertainty in earnings after the prepayment, use all available funds to lower your debt. This would reduce your burden on a monthly basis. If you’re financially stable, you can use your funds to pay off a comfortable portion of the loan and keep servicing the rest.
Money Saved on Interest Payments
Paying off an instant Personal Loan early can save you money on interest payments. To illustrate, let’s say a borrower needs a Personal Loan of ₹10 Lakh. They’re willing to accept an interest rate of 13% per annum for five years. In this case, the EMI will be ₹22,753. The total interest cost will be around ₹3.65 Lakh. If they pay off the debt, they might save ₹2.44 Lakh in interest after a year.
Personal Loan borrowers believe that to reduce interest payments, they should pay the loan early. However, individuals might reduce their EMI payments by paying off their debts early in the later years. An online calculator calculates how much interest you can save if you pay off the loan early. Those considering the prepayment option should also consider the prepayment penalties for Personal Loans.
Increase EMI affordability for borrowers
Paying off a Personal Loan early lowers the EMI/NMI (Minimum Net Monthly Income) ratio. This means the proportion of the EMI as a function of an individual’s income. Banks and Non-banking Financial Companies (NBFCs) will lend to clients whose monthly EMI payments are 50% to 60% of their income. This allows borrowers to qualify for a larger loan.
Interest on Prepayments
The Reserve Bank of India has banned prepayment fees for unsecured loans with variable interest rates.
On the other hand, Personal Loans with fixed interest rates are not subject to this stipulation. The typical penalty for paying off a Personal Loan early is five percent of the loan’s principal. Many loan providers prohibit partial prepayments or foreclosure until the borrower has paid a specified number of EMIs.
It’s beneficial for current borrowers to prepay their loans as it lessens their interest payments and total debt. If the provider imposes prepayment costs, the decrease in cash flow may be discouraging. Refinancing to a lower-interest lender may benefit a borrower with limited funds.
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