Often, there are situations in life when you have to meet a goal or an emergency financially, but do not have liquid cash or plenty of savings to do so. In such situations, many people consider taking personal loans from financial institutions and then pay them off with time.
However, a loan can often feel like an invisible burden on your shoulder, a weight that constantly reminds you of its presence. Many people opt for foreclosing their personal loans, so they can be free from worries and debt.
But did you know it is not all black and white with foreclosing your personal loans? There are pros and cons you must look into, to ensure you take the financial decision that is the best for you.
Sai Bhosale, a chartered accountant and financial advisor, gives her valuable insights when it comes to foreclosing a personal loan. “Foreclosure of loans means paying the balance outstanding loan in a lump sum by the borrower before the end of the scheduled repayment period. Foreclosure can also be done by the lender if the borrower defaults on the loan to pay by selling the borrower’s collateral,” Bhosale explains.
Pros Of Foreclosing Your Personal Loan
1.Saving Interest Of Subsequent Years
You can save tremendously on the sum you would have paid in interest. “Interest charged in initial years is higher as the outstanding balance of the loan is higher and therefore, foreclosure should be done preferably in earlier years to save interest expenditure, subject to availability of funds,” Bhosale educates.
2.Improves Credit Score
Your credit score and a clean credit report are important for any future borrowings to get quickly sanctioned. “The borrower is in a better position to raise funds from financial institutions in case of emergencies and contingencies when he forecloses his current outstanding loan,” Bhosale explains. She adds that a good credit score may help you get “attractive interest rates in the market”.
3.Reduced Debt Burden
“As rightly said by Henry Wheeler Shaw, an American humorist, ‘Debt is like any other trap, easy enough to get into, but hard enough to get out of.’ Foreclosure of personal loans is getting rid of the financial termite and enjoying some peace of mind,” Bhosale explains. It will free your feet from the chains of debt and help you focus on your financial goals.
4.Improves Financial Strength
“Personal Financial Ratios like Debt-to-Income Ratio and Net Worth Ratio give a clear snapshot of financial health and enable us to make better financial decisions,” Bhosale points out. She further adds that these ratios become favourable as soon as the debt is cleared.
Cons of Foreclosing Personal Loans
1.Lump Sum Payment requirement
“If the borrower opts to pay a lump sum for foreclosure of loan, he is compromising on his financial convenience and may put himself in a financial disarray in future due to non-availability of funds,” Bhosale explains. Hence, one must analyse their cash inflow and outflow, and where they can cut down expenses, before making a huge financial decision like this.
2.No Tax Benefits
“Borrowers are eligible for deduction of the principal component of the housing loan repaid from the total income under section 80C of the Income Tax Act, 1961 up to ₹1,50,000 while section 24 provides for deduction of the interest paid on home loans. The maximum interest deduction is ₹2,00,000 in the case of self-occupied properties. There is no ceiling limit for claiming a deduction of interest for rented properties,” Bhosale informs.
Deductions are also available on the interest component of loans taken for purchasing electric vehicles and for funding education. “However, it is advisable to opt for foreclosure of the loan if your total interest expenditure is greater than the benefit of tax deductions. Also, in case of multiple loans outstanding, get rid of the one which has the highest interest rate,” Bhosale explains.
3.Levy Of Penalties
Most banks and NBFCs charge a penalty for early closure or prepayment of loans. “Borrowers must carefully compare the interest saved and penalty levied by the financial institution and accordingly decide whether foreclosure is beneficial or not. However, as per the notification by Reserve Bank of India, Banks and NBFCs are not permitted to charge foreclosure charges/prepayment penalties on home loans/all floating rate term loans sanctioned to individual borrowers,” Bhosale asserts.
4.Lose Opportunity To Earn Income
Bhosale says that the borrower may lose the opportunity to earn income at a rate higher than the interest charged by the lender if he opts for closure of the loan by lump sum payment instead of scheduled EMI payments. “For example, one may decide to invest in Mutual Funds and grow their wealth and comfortably repay their loan over the years instead of hurrying to foreclose the loan. Also, this makes sense if you have procured the loan at a low-interest rate,” she explains.
“You must not only look at absolute numbers for loan foreclosure but also understand your financial capacity and liquidity needs and then make a decision which is in alignment with your financial goals,” Bhosale concludes.