Part Payment vs Prepayment vs Pre-Closure: When Is It A Good Option?
Understand the benefits of part payment and pre-closure of loans. Reduce your interest outflow and achieve financial freedom with early repayment.
Today there are few among us who do not have a loan in our names. Once we begin working and set out on our own, there are several occasions where it makes perfect economical sense to take a loan. For example, if you have to set up a home, while you could rent a flat and pay for the rent from your regular income, you would find it more practical to buy a home with the help of a loan. That way the money spent on rent could now be used to pay for the EMI. Thus, what would have been an expenditure could be turned into an investment.
No matter the kind of loan one takes - whether a home loan, a car loan or even a personal loan, one has to pay an interest. We are thus always on the lookout for ways and means to repay the loan at the earliest and reduce the interest.
There are two ways in which one can reduce the total interest outflow - part payment or pre-closure. Pre-closure is also often referred to as prepayment of a loan. In this article we discuss in detail what part payment and pre-closure/prepayment of loans entails and the benefits to the borrower.
Prepayment Of Loans:
A prepayment of a loan is when you close a loan early by paying the entire outstanding principal and interest on the loan in one go. This could happen when you suddenly have access to a lumpsum amount of money – either through a work-related bonus, or an investment maturing etc. However, most terms and conditions attached to loans include pre-closure charges or penalties. The pre-closure charges for personal loans can sometimes be rather high, often ranging between two to four per cent of the outstanding principal amount. Many lenders only allow a pre-closure of personal loans only after one year of the loan term. Some banks and lending institutions fortunately do not levy any pre-closure charges on home loans even while their pre-closure charges on personal loans can be rather high.
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There are often cases when borrowers pre-close a loan by transferring a loan to a lender offering lesser interest rates. Should you also consider this as an option, calculate the total amount saved by transferring your loan, after taking into account the pre-closure charges of the first lender as well as the processing charges of the lender to whom you are considering transferring your loan.
Part-Payment Of Loans:
It is relatively easy to pre-pay a personal loan or car loan as compared to a home loan as the loan amount is usually much smaller. However, in the case of home loans, this may be more difficult. However, should you come into a substantial sum of money, you could consider the option of part-payment of the loan amount. In this scenario, you pay a portion of your outstanding principal amount over and above the existing EMI. By reducing the principal amount, you reduce the overall interest amount that would be charged to you otherwise. Similar to prepayment of loans, most lenders will levy a penalty or part-payment charge on personal loans. In the case of home loans, some lenders waive this charge.
The table below will help you understand how a part payment can help you make an overall saving. It assumes that you have an outstanding loan amount of INR 500,000/- and have INR 100,000/- for a part-repayment. It also assumes that any saving in EMIs is invested @7% per annum.
|Repayment as per Original Schedule||Repayment with part-repayment|
|Interest Rate per Annum||20%||20%|
|Tenure||5 years||5 years|
|Total amount repaid after 5 years||794820||6,35,880|
|Total Interest Paid||2,94,820||1,35,880|
|Interest saved by part-repayment||1,58,940|
|Assuming Penalty levied on part-repayment @ 4% of Principal due, Penalty/pre-closure charges||20,000|
|Total Saving after paying penalty||1,38,940|
|Additional interest gained by investing saved EMI of INR 2,649/- calculated @7%p.a.||27,579|
|Total amount gained||1,66,519|
|If the INR 100,000/- had been kept in bank FD @ 7% for five years, value after 5 years would be||140,255|
As per these metrics, by partly repaying INR 100,000/- of your loan, you stand to gain INR 26,264/- at the end of the five-year period. These figures will change if the interest rate for the loan, interest rate for investment, loan penalty charges and other factors change.
It is therefore important to understand the monetary benefit to yourself if you decide to pre-close a loan or opt for a part-repayment after taking into account penalties and other charges. In the case of home loans, you should also keep in mind the tax rebate benefit offered up to INR 150,000/- of the principal amount while performing the calculation.
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