Personal loans usually have a repayment tenure anywhere between 12 and 60 months, or even longer in some cases. However, there may be times when the borrower decides to pay off the loan before the end of this tenure. This circumstance of prepayment is known as foreclosure. The lender, in this case, may lose some interest income that otherwise would have to be paid by the borrower over the original tenure of the loan. To compensate the lender for this loss of interest, sometimes borrowers are required to pay foreclosure charges.
Loan Foreclosure Charges
Most loans are paid back through EMIs after you get a loan. Loan foreclosure involves paying off the entire loan amount at once instead of multiple EMIs. You can opt for personal loan foreclosure if you have extra funds and wish to eliminate the EMIs. This allows for a complete repayment of the loan.
LoanTap charges a nominal fee of 5% of the principal outstanding plus applicable taxes if the loan is repaid within 6 months of loan disbursal. However, after 6 months, you are not required to pay any foreclosure charges.
Benefits of Loan Foreclosure
If you have opted for a loan foreclosure, it can benefit you in the long run. Below are some of the advantages of loan foreclosure.
Reduce Debt Burden
Personal loan foreclosure is a successful strategy to get out of debt. If you choose to foreclose, you can utilise any extra investments or savings to pay off your debts sooner. With loan foreclosure, you can ease the debt burden.
Saves Total Interest
Even though the interest rate may appear to be quite insignificant, the longer the loan term, the more interest you will have to pay. The interest paid by loan borrowers who get the loans for 20 to 30 years ends up being roughly twice as much as the principal. You can save a lot of money by choosing to foreclose on debt early.
Reduce the Loan Tenure
Foreclosure of a loan legally ends the contract between the borrower and lender before the loan tenure ends. This will eliminate the loan liability.
Offers Tax Benefits
Prepaying a personal loan might result in tax advantages for the borrower. Any loan prepayment made in addition to your EMI amount is considered principal repayment. As a result, the prepaid sum qualifies for a tax deduction under section 80C of the Income Tax Act.
Factors To Consider Before Opting For Foreclosure of Loan
- Prepayment and Foreclosure Charges – Foreclosure can be a great decision if you want to free yourself from the debt cycle. Although it is important to know that financial institutions charge up to 5% of the total outstanding amount as foreclosure charges. It is advisable to check for prepayment and foreclosure charges and terms before availing of the loan.
- Investment Options – Before choosing foreclosure, you should look at investment opportunities that can provide great returns. Consider investing your excess cash in equity or equivalent instruments, for instance, if mutual fund investments or equities have a better chance of growth. This will result in a bigger return. Spending the spare money for pre-closure seems sensible if you are unsure about the future return.
- Limited Tax Benefits – Although the prepayment provides a tax deduction, you must be aware that you can only deduct up to ₹1.5 lakh for the principal payment of a loan under Section 80c and ₹2 lakhs for the interest payment of a home loan under Section 24(b). You might not receive any tax benefits for payments made above this threshold.
Lenders impose foreclosure charges to compensate for potential loss of interest income due to loan prepayment. Knowing about these charges will help you make informed decisions regarding when or even if you should repay the loan before the end of the tenure. You must review the terms and conditions of your loan agreement carefully to assess the impact of foreclosure charges. To make sure that you are not caught off guard by the terms of the agreement, it is best to review them carefully before taking out the personal loan.