Here’s a fact! When it comes to personal loan repayment, many borrowers prefer to close the loan before the loan tenure ends. Are you also pondering over whether prepayment is a viable option? Wondering how it will affect your credit score? Let’s find out.
Impact of loan prepayment on credit score
Your credit or CIBIL score impacts your future loan approval chances and the interest rates and loan amount you qualify for. Paying your loan EMIs on time spells wonders for your credit score. But does the same logic apply to prepayments? Unfortunately, no.
When you prepay a personal loan, your credit history reflects a closed account. However, when CIBIL calculates your credit score, it only considers how you’re servicing your active accounts. Effectively managing your open accounts have a more positive impact on your rating, than say, a closed account.
CIBIL prefers active accounts over closed accounts because having the former indicates your ability to manage finances effectively. If you are a first-time borrower, making the repayment as per the loan schedule will help you boost your credit history and score.
With that said, if you already have a healthy CIBIL score, closing off a loan early won’t necessarily hurt your rating. However, it won’t have a positive influence either. Additionally, it can signify to your future lenders that you make timely debt repayments.
Things to consider before making loan prepayment
Besides your credit score, loan prepayment also affects other factors which can hurt or heighten your creditworthiness. Here are some of them.
#1 Debt-to-income ratio
Like credit scores, your debt-to-income (DTI) ratio is also a personal loan eligibility factor lenders consider before forwarding you a loan. Having a high DTI means that a chunk of your income goes into servicing loans. This can hurt your chances of loan approval.
Prepaying a loan can help you bring down your DTI ratio, as you would no longer have to spend a part of your income managing the closed loan. This can help you get future loans effortlessly.
Although you get to walk debt-free, prepayment can drain your savings, especially if you’re thinking of closing the loan within the first few months or years. Also, many lenders charge prepayment fees if you close the loan early. The fee charged on the outstanding loan amount usually ranges between 2.5% and 6%. As a result, your overall repayment costs can increase.
To prepay or not to prepay – the solution lies in your preferences. Closing your loans early can help you save a lot on the interest payable. However, the amount you save depends on the prepayment or foreclosure charges and personal loan interest rates.
If you’re paying more in interest than foreclosure charges, it’s recommended to prepay the loan. However, if the converse is true, it’s better to hold on to your loan. To get a better idea, you can use a personal loan EMI calculator for factoring in the foreclosure charges.