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6 Factors to consider when prepaying your personal loan

Despite a personal loan being a costly option, it is an excellent choice for those with immediate requirements for funds. SBI personal loan eligibility or eligibility criteria for other lenders depend on the applicant’s credit score, income, location, age etc. While the SBI personal loan interest rate or interest rates charged by other lenders might be relatively high owing to their unsecured nature, there is zero restriction on their end usage.

However, considering a usual abhorrence to debt, many try to prepay their personal loan, no matter if their loan was at a lower SBI personal loan interest rate. They do so with surplus funds, which they receive from their organization or through investments. They choose the Prepayment option because it helps the personal loan borrowers to reduce their interest component outgo by a massive margin. However, before the borrower opts for the prepayment option, they should consider certain factors before prepaying their personal loan.

1. Prepayment/foreclosure charges

Personal loans available at floating interest rates do not incur any prepayment charge as RBI has debarred banks from penalizing the prepayment charge on retail loans. However, for personal loans being offered at a fixed interest rate, prepayment charges can go as high as 5% of the principal outstanding based on the lender. Thus, for those with a fixed interest rate, personal loans planning to prepay should note, prepayment charges can turn out to be substantial when prepayments are made in a staggered manner instead of prepaying the whole loan at a go. 

Thus, ensuring to check up on your personal loan prepayment charges before availing of a personal loan is crucial. It is equally crucial to check your personal loan eligibility or eligibility with other lenders or consider opting for a lower SBI personal loan interest rate or other lender’s rate. Ensure to opt for the lender offering a personal loan at no prepayment charges, as doing so would help you prepay your personal loan without having to incur any additional costs.

2. Interest savings

The major motive behind prepaying your personal loan is to save on the high-interest cost. However, it is a misconception that prepayment in the beginning stages leads to savings on interest and not in the later stages. The truth is interest savings exist in later stages as well. Using an online personal loan prepayment calculator can calculate their interest savings and ensure that their interest savings surpass their prepayment charges.

3. Impact on your contingency fund

The next crucial factor to consider while you decide to prepay is its effect on the emergency fund. Ideally, an emergency fund should be at least 6 times your mandatory monthly expenses. Suppose it makes a dent in your emergency fund. In that case, you should not consider prepaying your personal loan as the basic purpose of an emergency fund is to meet your requirements at the time of financial emergencies like loss of job, severe illness etc. Else, any unforeseen situation may propel you to go for loans at higher interest rates.

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4. Returns from existing investments

The return from your existing investments like mutual funds, fixed deposits, insurance policies etc., can have an impact on the decision to prepay your personal loan. However, you should not redeem them to prepay your personal loan if they yield higher returns than the rate of interest paid on a personal loan. For instance, if your SBI personal loan interest rate costs you 13% pa and you have a fixed deposit, which incurs 5% pa interest but is not attached to any particular financial goal, then you can consider redeeming your fixed deposit to prepay your personal loan as your yield is lower in comparison to your outgo.

5. The opportunity cost of not investing

Opportunity cost refers to the cost of opting for an alternative over another. It is true in the case of equity funds, stocks and others in situations of a market correction when it is available at a lower NAV. Thus, the opportunity cost of forgoing investing is primarily the returns you are letting go of by not investing and choosing to prepay your personal loan instead. Thus, avoid diverting your contributions specifically earmarked for long term financial goals through mutual funds so as to prepay your personal loan.

6. Planning to apply for a new loan

Most of the lenders usually prefer their applicants to contain their EMI to NMI (Net Monthly Income) or GMI (Gross Monthly Income) ratio to be within 50 to 60%. The EMI portion of this specific ratio includes the EMIs of the new loan and existing loan. Thus, those personal loan borrowers looking to take up another loan, may it be another personal loan, home loan or car loan, surpassing the EMI/GMI or NMI ratio of 50% to 60%, can increase their SBI personal loan eligibility or loan eligibility for other loan options with other lenders by making their existing personal loan prepayment and thus lowering their EMI/GMI or NMI ratio. 

Advantages of opting for personal loan prepayment

It makes you debt-free faster

One takes a personal loan for taking care of their crucial expenses, which they require repaying in the form of EMIs. Note that if such EMI is not managed in a prudent manner, your personal loan can result in financial distress. Personal loan EMIs even take away a huge chunk of your savings. It is the reason why it is often advised to prepay your personal loan completely if you have any additional income on your way. When you make a prepayment of your loan, you might have to repay a prepayment charge in case it is a fixed rate personal loan. 

Prepayment refers to lowered interest outflow

When it is about loan prepayment, one of the major aspects to factor in is the lock-in period. It refers to the period when the lender does not permit the borrower to make a prepayment, partial or full, towards their loan amount. However, once the loan’s lock-in period gets over and when you have some surplus income, try to prepay your loan either partially or fully. Doing so would save you a substantial interest amount that is applicable to your borrowed amount.

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Marketvein Staff
Marketvein Staff
Born libra, likes to lead from the front. Digital Marketing & Technology is his strength. He has pursued engineering. Travelling to new places & writing is his idea of fun. In his free time (if he gets some that is), he is seen donning the chef's hat at home.
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