Foreclosure: Definition, Process, Downside, and Ways To Avoid

Foreclosure can be a daunting process for homeowners. Learn about the definition and steps involved in foreclosure, as well as its potential downsides!

20 Feb,2023 10:23 IST 2748 Views
Foreclosure: Definition, Process, Downside, and Ways To Avoid

A lot of us find financing a house, vehicle, or vacation difficult because we may not be able to pay the entire cost upfront. It is in such a situation that the option of a loan comes in handy. 

However, a change in the financial circumstances such as inheritance, bonus or sale of an asset may force some borrowers to rethink about the loan. This is where a loan foreclosure could be an option.

What Is Loan Foreclosure?

Loan foreclosure is the option a borrower has to pay off the loan before the term ends. Borrowers repay loans ahead of the tenure for a number of reasons, including saving on EMIs or reducing their debt burden.

There are two types of foreclosure—full and partial foreclosure. Full foreclosure occurs when the borrower pays off the entire loan balance and the loan account is closed. Partial foreclosure is when the borrower makes partial payments and settles some future installments ahead of time.

Process Of Foreclosing A Loan

The loan foreclosure comprises a number of steps, though the actual process may vary from lender to lender.

Application For Foreclosure:

The process begins with an application submitted to the bank or non-banking financial institution requesting foreclosure of the loan. All relevant documents, including the current home loan account number, a copy of the PAN card, and proof of address need to be provided along with the application.

Payment And Charges:

Once the application is processed, the bank or the NBFC will inform the borrower about the exact amount that needs to be paid. The amount will also include prepayment or foreclosure charges based on the type of loan being foreclosed and the institution from which the loan is taken. 

Discontinuation Of The Loan:

Once the outstanding amount is repaid, the bank will start the foreclosure process. In case of a full foreclosure, the EMI payments will be immediately stopped. The lender typically returns the original documents to the borrower within 10 to 15 working days. The borrower should make sure that they get a no-dues certificate from the bank or the NBFC. This certificate is a formal document that certifies that all debts and liabilities have been cleared.

Downsides of Foreclosure

While a loan foreclosure has several advantages, it also has certain disadvantages.

Losing Out On Tax Benefits:

A home loan will allow the borrower to claim tax benefits of up to Rs 1.5 lakh on the principal amount and deductions of up to Rs 2 lakh on interest payments. Foreclosure of a home loan could mean the borrower will lose out on these tax benefits. 

Loan Prepayment Penalties:

Most banks and NBFCs have loan foreclosure clauses that specify the prepayment or foreclosure charge that will be levied from the borrower when the loan is prepaid. This means a foreclosure of a loan would include other expenses beyond the lump sum payment of the remaining loan amount.

Losing Out On Other Investment Opportunities:

While one might be tempted to clear debt at one go, it may not be always a good idea to repay the loan ahead of schedule. Foreclosure of a loan often represents a massive outlay of capital and could affect your short-term liquidity and flexibility. Instead, another option could be to invest the funds in instruments that could earn better returns than the interest rate on the loan. 

Foreclosure May Not Necessarily Improve Your Credit Score:

Foreclosure or repaying the loan before the due date will not have any significant impact on your credit score. Payment history is one of the most important things a credit score algorithm will look at and prepaying loans early can mean lesser time for building that track record. Effectively managing loan accounts that are open will have more impact on credit scores than prepaying an existing loan.

How To Avoid Foreclosure

In some cases, lenders themselves initiate the foreclosure process. This happens when the borrower fails to repay the loan on time and despite reminders. In such cases, the lenders may seek to take possession of the property in lieu of the unpaid loan. The borrowers can take recourse to several steps to prevent the lender from foreclosing on their home.

• The borrowers should try to arrange enough money to pay back the missed mortgage payments.
• The borrowers can try to refinance their loan with either the existing lender or another lender that is offering a lower interest rate or a longer tenure to reduce the EMIs.
• The borrowers can even ask their lenders for a period of forbearance when they don’t have to pay the EMIs.
• The borrowers can also reach out to their friends or family members and seek financial help to avoid the foreclosure.


Whether it is better for a borrower to foreclose a loan will depend on a number of factors including the interest rate on the loan, remaining tenure of the loan and the prepayment penalty.

If one has idle cash, it is better to prepay a personal loan in the early part of the loan to save on interest. It may not make much sense to prepay towards the end of the tenure, especially if prepayment charges are high. As a thumb rule, if the cash in hand earns less than what the borrower pays as interest plus penalty, it makes sense to foreclose the loan.

NBFCs like IIFL Finance offer new home loans and balance transfers and loans against property at attractive interest rates. IIFL Finance also allows borrowers to easily foreclose their loan account by paying a nominal fee.

Disclaimer: The information contained in this post is for general information purposes only. IIFL Finance Limited (including its associates and affiliates) ("the Company") assumes no liability or responsibility for any errors or omissions in the contents of this post and under no circumstances shall the Company be liable for any damage, loss, injury or disappointment etc. suffered by any reader. All information in this post is provided "as is", with no guarantee of completeness, accuracy, timeliness or of the results etc. obtained from the use of this information, and without warranty of any kind, express or implied, including, but not limited to warranties of performance, merchantability and fitness for a particular purpose. Given the changing nature of laws, rules and regulations, there may be delays, omissions or inaccuracies in the information contained in this post. The information on this post is provided with the understanding that the Company is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. As such, it should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisers. This post may contain views and opinions which are those of the authors and do not necessarily reflect the official policy or position of any other agency or organization. This post may also contain links to external websites that are not provided or maintained by or in any way affiliated with the Company and the Company does not guarantee the accuracy, relevance, timeliness, or completeness of any information on these external websites. Any/ all (Gold/ Personal/ Business) loan product specifications and information that maybe stated in this post are subject to change from time to time, readers are advised to reach out to the Company for current specifications of the said (Gold/ Personal/ Business) loan.

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