Is pre-closing your personal loan a smart move? Pros and cons explained

Pre-closing a personal loan from any bank is a good financial decision, but one must be cautious while doing so by keeping certain important points in mind. Firstly, a personal loan is a very risky line of credit that borrowers avail.

This is risky because it comes with the potential of higher repayment terms, interest rates and EMIs. That is why borrowers need to carefully consider all the associated intricacies of the loans they aspire to avail before availing them. Similar goes with the pre-closing of a personal loan. Here’s what borrowers need to clearly understand about the pros and cons of this option:

Basic concept of personal loan pre-closure

Pre-closure of a personal loan simply means repayment of the entire loan amount before the due date. It is an excellent option for individuals with surplus funds and wish to settle the debt early.

Pre-closure also avoids huge interest outgo, as interest continues to accumulate with the lapse of time. It can even provide a boost to an individual’s credit rating and credit score by settling outstanding loans, thus increasing borrowing capacity in the future.

What are the advantages of pre-closing a personal loan?

• Savings on Interest: Saving interest is one of the most compelling reasons to pre-close a personal loan. The earlier you pre-close your loan the less amount of interest rate you end up paying overall.
• Improved credit score: Pre-closing the loan can also help you improve your credit score because it comprehensively reflects a healthy borrowing and repayment pattern.
• Financial Freedom: Pre-closing allows the borrowers freedom from the burden of paying periodic EMI, providing greater financial freedom to invest elsewhere or save.

What are the drawbacks of pre-closing a personal loan?

• Pre-closure charges: Every lender levies early repayment charges, which are between 2% and 6% of the loan outstanding. Such charges typically equal the above-stated interest savings.
• Opportunity cost: The money used in pre-closure can be invested somewhere else such as: Equities, mutual funds, ULIPs etc. If your rate of return is greater than your saving of interest with pre-closing, then it would be advisable not to repay the loan.
• Liquidity problems: A big amount borrowed for pre-closure could result in a problem of liquidity as fewer cash would remain in hand for immediate challenges or any other investments.

Note: For the exact details on pre-closure charges consider reaching out to your respective financial institution. The charges discussed here are for illustrative purposes.

The RBI’s new guidelines

The Reserve Bank of India has released new guidelines for erasing prepayment charges on floating-rate loans on February 21, 2025. If it is implemented, the same may bring additional convenience of borrowing to the borrowers and relief from monetary troubles of prepaying ahead.

RBI has invited public and stakeholder comments on the draft until today i.e., March 21, 2025. After that, the central bank will take a final call on this concept. Therefore, pre-closing a personal loan is great but has to be balanced against costs and an individual’s net financial situation.

(Note: Raising a loan comes with its own risks. So, due caution is advised)