Difference between Prepayment, Part Payment and Pre Closure

Taking a loan is not difficult these days. Any kind of loan can be availed by sitting at your home comfortably or visiting the nearest bank branch. However, what is not easy is to plan your repayment options.

As we know the loan is borrowed as a lump sum amount and has to be repaid in parts at a specified rate of interest. However, the interest payments can be financially stressful for some people. If that is the case, then the borrowers can opt for pre-payment, part payment, or pre-closure of the loan.

This article highlights everything you need to know about pre payment, part payment, and pre closure of loan.

Understanding prepayment of a loan

Prepayment is an option provided by lenders under which the borrower can pay the outstanding loan amount through part payment or full payment prior to the repayment schedule. Prepayments can be done for various types of loans including business loans, home loans, personal loans, etc.

You can access the pre payment option when you have surplus money or the ability to arrange lump sum loan amount and repay it to the lender. Most banks allow the borrowers to prepay the outstanding principal loan amount after 12 months.

Each prepayment directly chips away the loan’s outstanding principal amount, as regular EMIs primarily cover interest. Thus, the prepayment option enables the borrower to save the total interest and pay the debt early.

Sometimes the bank might impose foreclosure charges of 2-5% on the outstanding principal amount. In order to examine the effect of the prepayment charges on your loan amount, it is fruitful to use an EMI Calculator.

As per the recent guidelines of the Reserve Bank of India, the bank does not have the right to charge any penalty on the prepayment of the loan amount taken on a floating interest rate. However, this rule does not apply to personal loans as they are typically taken on a fixed interest rate.

Pros and Cons of prepayment of loans

Here are some of the pros and cons of prepayment of a loan:

Pros of prepayment

• Lower interest paid on the loan amount
• Faster Debt Repayment of your loans
• Chances of Possible improvement in credit score

Cons of prepayment

• One needs to make larger payments for a discernible effect
• Prepayment Penalty Charges are imposed
• It negatively impacts the liquidity

Understanding the Pre closure of Loans

Preclosure of a loan also referred to as foreclosure is a situation in which you repay your remaining loan amount completely in a single instalment before the scheduled EMI period.

Preclosure allows you to save a considerable amount on interest and EMI amounts as you can wrap up the principal outstanding in one shot. It has a positive impact on your creditworthiness as it increases your credit score.

In order to opt for the preclosure of the loan, the borrowers need to consult their respective lenders or banks. The bank will look at three factors while accessing your pre closure application. These are:

• Total outstanding loan amount to be paid by the borrower
• The remaining repayment schedule
• The interest outgo by the borrower

If the bank finds the calculations of the outstanding loan satisfactory, then you can pre close the loan before the actual repayment schedule. Typically, in the case of a personal loan, the lock-in period is one year which means that during this period, you are required to make regular payment of the loan.

It is only after the lock-in period, that the bank will allow you to pre pay the balance and settle the loan amount. Make sure that you collect the original documents and the no-due certificate from the lender after the settlement of the loan account.

Pros and Cons of preclosure of a loan

Pros and cons of preclosure of a loan are:

Pros

• Interest Savings on the loan
• It makes the borrower Debt-Free Sooner
• Possible improvement in Credit Score

Cons

• Foreclosure charges are imposed
• There will be a Loss of Tax Benefits

Understanding the part payment of a loan

Part-payment of a loan is an option that enables you to reduce your principal amount significantly. The part payment generally takes place when the borrower has a substantial amount of idle money less than the outstanding principal amount.

The borrower deposits this idle money into the loan account resulting in a reduction in the unpaid debt amount. Consequently, both the EMI and the total interest amount decrease.

Nevertheless, it is crucial to understand that the advantages of modified loan tenure are discernible only if the borrower pays a significant amount of lump sum money as part payment amount.

Thus, Partpayment is a good option when you have a significant amount of surplus funds as it reduces your monthly EMI commitments.

The part payment amount gets subtracted from the borrower’s outstanding principal amount after making the payment. However, the borrower must consider their decision while making a small part-payment especially if their bank imposes prepayment charges. Part-payment of a loan has a trivial effect on the credit rating of the borrower.

One advantage of part payment is that you are not restricted to opting for this option only once, instead, you can make part payment more than just once depending upon your capability.

Irrespective of how often payment is made, making part payment of a loan will result in a reduction of the total interest paid and the EMI paid on the total amount.

Apart from the advantages that are offered by the part-payment option, a major disadvantage of it is that banks do not allow you to avail the part-payment option on specific loans such as personal loans as there is a lock-in period in case of a personal loan.

Pros and Cons of part payment of loans

The pros and cons of part payment of a loan are:

Pros

• It results in faster loan repayment
• Ensures cost savings
• It can bring down the interest paid on your loan

Cons

• Prepayment charges may be imposed
• It impacts the liquidity

Key differences between part payment, prepayment and pre-closure of loan.

The key differences between the part payment, prepayment and pre-closure are listed below:

Principal Amount

• Part-payment of the loan reduces your principal amount
• Prepayment of the loan may reduce your principal amount or lead to foreclosure of the loan.
• In pre closure, the loan amount gets repaid completely.

Interest payments

• In the case of part payment of the loan, the interest rate remains the same but the total interest paid reduces.
• In case of prepayment of the loan, the interest paid will decline but the interest rate will remain the same.
• In the case of pre closure of the loan, the total interest paid will reduce.

EMI

• Part payment of the loan reduces your EMI
• Prepayment of the loan reduces your EMI
• In pre closure, the loan amount gets repaid completely.

Conclusion

Many lenders and banks offer competitive interest rates. However, borrowers prefer to be debt-free as soon as possible. Therefore, prepayment and preclosure options make sense that way. It is always beneficial for the borrower to invest their surplus funds in their loan account resulting in a significant reduction of the interest paid or loan tenure.

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