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One of the most crucial areas that all borrowers should consider before availing a personal loan is prepayment. As suggested by the name, prepayment is an option provided by financial institutions allowing customers to pay their loan prior to the expiry of the loan’s due date. For instance, if a customer decides on availing a loan from ‘X’ Bank for five years with the rate of interest set at 15%, and the customer’s income suddenly rises during the third year of the loan, thus enabling him/her to complete making repayments well in advance of the due date, the customer can opt to repay the whole amount by the end of the third year. The terms and conditions of the loan will determine the manner in which the customer can do so.
The cost of lending is always lower in comparison with a customer’s cost of borrowing. For instance, a customer can avail a loan at 15% interest, but the savings made per annum will be no more than 9% to 10%. At the same time, the customer will have to pay 15% interest on the pending loan amount. Should the customer make use of the option to prepay, the loan amount can be repaid instantly, thus saving an extra 5% to 6% on interest per annum.
The amount of money spent by a bank to borrow funds is lower in comparison with its lending price. After lending the money, the bank earns the difference in the amount for as long as the loan runs. Should the customer opt for prepayment, the rate of interest that the bank would otherwise earn over the extra period decreases. Prepayment fees are charged by some banks to make up for the loss of potential income.
The prepayment fees charged by banks vary considerably among banks. There may be multiple restrictions depending upon which bank a customer borrows from, but generally, the rate of interest is between 4% and 5% on the outstanding loan amount. Moreover, prepayment fees can also differ depending upon the completed loan tenure. While zero prepayment fees may be offered by some banks after three years, some others provide discounted rates following a certain time period.
Customers are advised against going for packages that provide low prepayment fees. The first thing to do would be to compare the interest rates against prepayment charges. If the prepayment fees are low but the rate of interest is high then it is advised that you choose the one with lower interest. The prepayment calculator can be used to monetize the advantages you could potentially receive from low prepayment charges. The probability of prepaying the loan amount must also be assessed as prepayments are largely determined by the financial standing of a customer. If the customer is expecting a considerable rise in income then prepayment fees must be considered, if not, packages with low rates of interest may be the best option for you.