If you have ever taken a loan, you would know how important it is to go “debt free”. It is an extremely liberating feeling. You feel so unburdened that it almost gives you wings. Much as you would like to get rid of that debt, as soon as you can, the million dollar question is, “is pre-paying a loan the most optimal and economical choice?” In some cases, yes while in others it’s not.
You have just been promoted, got a fat bonus, won a lottery, an inheritance or whatever could be the source of your windfall gain, be doubly sure before you rush to pay to the bank. There are several parameters to consider before you hop on the bandwagon. Calm down and evaluate all aspects. We shall examine the various aspects involved in prepayment of a personal loan. Let us look at them one at a time.
Invest or Prepay?
Take the case of Mr. Anand Mehta. He took a personal loan for 5 lakhs from ICICI Bank for five years at 15.00%, two years ago. He has just received his annual performance bonus of Rs. 3 lakhs. Should he invest or prepay?
Prepaying is Costly
Making an investment is not the only aspect that you should consider. Some other things to keep in mind are:
Interest already Paid in 2 years: 86,753
Interest to be paid in 5 years: 1,67,000
+ PreClosure Penalty: 9100
+ Processing Fee: 10000
Total: 272, 853
Interest to be paid on existing loan: 2,17,000
+ Processing Fee paid initially: 10,000
Loans that are pure expense, don’t help you with tax rebates or help build an appreciating asset are bad loans. These must be prepaid at the onset of any opportunity. For example, the idea of prepaying a home loan is different from the idea of prepaying a personal loan.
The psyche of the borrower is also very important. Inspite of the costs involved, some people would just get rid of the debt whatsoever because they don’t want to carry the financial burden when they go to bed. In simple economics, if the extra money you have earns fewer returns than the interest you pay on your personal loan, it is prudent to pay off the loan.
great description and blog..
thanks for sharing
Nice Article. There is always pros and cons of every aspect. Indian Customers usually have this dilemma regarding loan. Today also people think loan as liability and ready to pay asap.
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