Pros & Cons of Prepaying Your Personal Loan

Usual aversion to debt often makes many prepay their loan as and when they receive surplus funds.

In the case of personal loans, the choice to opt for prepayments becomes even stronger than other credit options owing to their high interest rates, which can go up to 24% p.a in case if a personal loan is availed through MoneyTap Loan or via Instant personal loan apps.

However, before you opt for the prepayment option on your personal loan, it is necessary for you to weigh all pros and cons linked with this choice. Doing so would help you make an informed decision.

Pros

Saves on Interest Cost

The major reason to opt for personal loan prepayment is to save on the heavy interest cost. For instance, suppose you avail a personal loan from MoneyTap Loan or through Instant personal loan apps of the loan amount of Rs 5 lakh where the interest rate is 17% p.a and loan tenure is 6 years, the loan EMI will be Rs 11,123 with a total interest payable of Rs 3,00,861. If you decide to fully prepay at the end of the first year, the overall interest saving will be Rs 2,19,817.

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However, there exists a common misconception that only prepayment in starting stages of the loan can lead to interest cost savings and not in later stages of the loan tenure. The truth is interest savings exist in the later years also.

With the help of the online personal loan prepayment calculator, one can simply calculate the interest savings incurred through prepayment. You should choose this option when you see a possibility to save a sizable amount after factoring in the prepayment fees if any.

Lowers EMI/NMI or GMI Ratio

Lenders like MoneyTap Loan or instant personal loan apps give preference to those loan applicants with an EMI to NMI(Net Monthly Income) or GMI(Gross Monthly Income) ratio of 50-60%. This involves EMIs of the existing loans and the new loans.

Thus, the existing personal loan borrowers, if planning to take up another loan, such as car loan or home loan and are surpassing the limit of their EMI/NMI or GMI ratio, can boost their loan eligibility chances by making personal loan prepayment and thus lower their EMI/NMI or GMI ratio.

Lowers Concentration of Unsecured Loan in Credit Mix

Credit mix, i.e. concentration of one’s secured and unsecured loans, is one of the factors considered by the credit bureaus for calculating a credit score. Lenders like MoneyTap Loan or instant loan apps generally prefer lending to those with a higher concentration of secured loans, namely home loans, car loans or loans against property in their credit mix; as a result, bureaus also tend to positively score such borrowers.

As personal loans are unsecured in nature, their higher concentration in your credit mix may negatively impact your credit score. Thus, prepayment of unsecured loans, which includes personal loans, would result in an increase in the concentration of secured loans in your portfolio, which would further boost your credit score.

Cons

Prepayment Charges

While personal loans at floating interest rates do not attract prepayment charges, their availability at fixed rates incurs prepayment charges. Personal loans at fixed interest rates levy prepayment fees of usually up to 5% of the principal outstanding amount based on the lenders like MoneyTap loan or instant personal loan.

Note that most lenders that offer loans at fixed interest rates do not permit the option of part prepayment of personal loans. Additionally, there are even some lenders that disallow part prepayment before the borrower repays a predetermined number of EMIs.

Impact on an Emergency Fund

There are many personal loan borrowers who may use their allocations for emergency funds to prepay their personal loans for lowering their interest costs. Note that doing so may massively affect your financial health in situations of financial emergencies or income loss due to job loss, disability, illness etc.

Such financial emergencies usually force one to either redeem their investments meant to achieve long term goals or opt for loans at higher interest rates. Thus, prepayment of personal loans with adequate surpluses should only be considered once you have factored in your emergency funds.

The Opportunity Cost of Failing to Invest

In reference to prepayments, an opportunity cost refers to the lost opportunity of getting higher returns just by routing your surplus funds for personal loan prepayment purposes instead of investing it. In a simpler term, it refers to the distinction between returns on investment that you tend to forgo for making personal loan prepayments and savings in the interest cost on personal loan prepayments.

The opportunity cost of not investing is extremely higher for stocks and equity in the course of bearish market situations or steep market corrections at a time when they can easily be availed at an attractive valuation. The returns yielded through equity investing during such market conditions may be extremely higher than the savings generated on interest cost through personal loan prepayments.

Bottom Line

A personal loan from Instant Personal Loan apps, MoneyTap Loan or through banks or NBFCs is one of the highly preferred means for tackling financial shortfalls for many in immediate need of cash. The major reason behind the popularity of personal loans is that there are no restrictions involved in the funds’ end usage.

Be it for festival celebration, travel, children’s higher education, wedding preparation, purchasing gadgets or making home renovation, the financial product can be used for various reasons except for any illegal activities. Moreover, the loan does not need any security or collateral, unlike secured loan instruments such as loans against securities, loans against property etc.

While personal loans endow a lot of conveniences, their availability at a higher interest rate than secured loan options is one of the major drawbacks. Owing to this reason, there is an extremely high amount of competition in the banking sector wherein a lot of lenders such as MoneyTap Loan or Instant Personal Loan apps may offer personal loans at competitive rates.

However, even if a personal loan is available at an attractive rate, it can never be lower than secured credit options. Thus, one always has the option to opt for prepayments, which helps at lowering their total interest cost outgo.

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