An unsecured personal loan extends an array of benefits to borrowers like quick disbursal, no end-use restrictions, substantial credit amounts, etc. However, owing to its unsecured nature, lenders often charge a higher interest rate which raises the cost of payable EMIs. Hence, individuals often choose the prepayment facility for this credit instrument to lower the interest burden.
In some cases, lending institutions levy prepayment penalty to individuals who opt for advance payments. Thus, it is imperative to be aware of the various aspects of this penalty.
Why do Lenders Charge a Prepayment Penalty, and How to Avoid It?
All credit instruments come with a specific tenor, and lenders expect a certain amount of interest income from them over time. Therefore, when a potential borrower opts to repay a credit instrument quicker, the concerned lender earns a lesser interest amount. This is the reason why financial institutions charge a prepayment penalty.
An individual can avoid paying the prepayment penalty and foreclosure charge if they opt for a loan at a floating interest rate. Also, individuals must avoid opting for frequent refinancing from their lenders. This is because frequent refinancing indicates a lending institution that the individual is more likely to refinance as soon as the interest rates dropdown.
Things to keep in mind before choosing prepayment for a personal loan
Timing a personal loan prepayment goes a long way in determining whether or not it would be a beneficial option for the individual. Deciding this timing depends on an individual’s financial goals and some other calculations. Given below are some instances where a prepayment comes to use:
- When a substantial loan amount is involved
Borrowers who have procured considerable credit through a personal loan might find it difficult to pay it off before the actual tenor. However, one may opt for a part prepayment of the outstanding loan balance and still reduce interest payments.
- When a significant period of the repayment tenor is remaining
Personal loan prepayment proves to be beneficial when a considerable period of loan tenor is still remaining. Financial institutions levy charges on a prepayment at a specific rate on the outstanding balance, including taxes. Thus, if a credit instrument has run for an extended period, the borrower has already paid quite a considerable amount, implying that the applicable prepayment charges will be substantial.
- When a borrower has got multiple debt obligations
Borrowers with several debt obligations can reduce their financial burden by opting for the part prepayment facility. After part prepayment, they can revert to the same equated monthly instalments. Going for this procedure will help them quickly get relieved from one of the multiple debts.
Tax Benefits on Personal Loans
Besides the above-mentioned details regarding prepayment penalty, potential borrowers must note that they can enjoy personal loan tax benefits according to the Income Tax Act 1961. As per this act, certain scenarios can help lower the tax outgoes.
Below mentioned are the various scenarios for tax benefits of a personal loan:
- Individuals can enjoy tax benefits if they use a personal loan to buy assets like jewelry. They can claim these benefits as and when they sell the asset.
- According to section 24 (b) of the Income Tax Act, individuals can enjoy tax deductions if they use a personal loan to construct or purchase a residential property.
- Individuals can claim the interest they pay towards a personal loan as a tax-deductible expense if they use this credit instrument to finance their business expansions.
Also, it is imperative to note that personal loan tax exemption for salaried individuals is not available.
Besides, potential applicants must always choose a reputed lender while applying for this credit instrument. This will help them benefit from several pre-approved offers that are offered on both secured and unsecured financial products. These offers help simplify and accelerate the lending process. Customers can check their pre-approved offers by providing a few details, such as their name and contact number.
Thus, borrowers willing to pay off their credit early must be aware of the above-mentioned details related to the prepayment penalty. Also, prospective applicants must use a personal loan calculator before applying to manage their repayments efficiently.