What You Should Know About Foreclosure of Loan or Prepayment of Loan?

What You Should Know About Foreclosure of Loan or Prepayment of Loan?

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What is prepayment of loan?

Prepayment of loan means that an individual decided to repay loan early by making part payment or full payment based upon his capacity.  Foreclosure of loan is the term used when you pay full amount of loan earlier than the scheduled time and prepayment of loan is the term used either for full or partly payment of loan. You must be thinking why it is important to pay loan early?  soon you will find reason in this article.

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What happens when you prepay a loan?

By making early prepayment of loan you can free yourself from paying monthly instalments (EMIs) and use money for other specific goals on priority. This will relieve you from financial burden and at same time help you in planning your future in much better manner. We are talking about all types of loans like home loan, education loan, personal loan, car loan and other loans.

Paying EMIs on loan no doubt result in creation of assets like house, car and so on for which you have sanctioned loan . But at the same time result in no saving for future or curtailment of present standard of living.  So we can simply say it brings hardship to the present living. Sometime we have to take loan for meeting some goals but best thing is to repay the loan as and when you receive some large amount either through bonus, dividend, capital gain, rent or other means. 

Prepayment of loan

Prepayment of loan calculator

Let’s take an example:

 Mr. XYZ  urgently got sectioned a home loan of Rs 60 lakh for purchasing property at Noida from a bank. The rate of interest is 7% per annum and period of loan is 20 years. Here EMI comes to Rs 46,517.94 per month and from the table you can clearly get an idea about the how much money he will pay for whole tenure if he follows bank schedule or if he decides to pay Rs 60000 per month instead of bank EMI Rs 46,517.94 per month.  Let’s compare the scenarios.

Scenario 1: When you pay loan as per schedule

  • Loan Taken from bank: Rs.60,00,000
  • Rate of interest: 7%
  • Loan duration: 20 yrs
  • EMI: Rs.46,517.94
  • Total interest to be paid over loan period: Rs.51,64,304.67
  • Total amount paid over the loan period (Principal + Interest): Rs.1,11,64,304.67.

Scenario 2: When he will pay EMI Rs.60,000 (More than EMI Rs.46,517.94  decided by Bank). 

  • Loan Taken from bank: Rs.60,00,000
  • Rate of interest: 7%
  • Earlier loan duration was 20 yrs but extra EMI the loan will be paid with in 12.58 yrs. He saved 7.42 years faster.
  • EMI: Rs.60,000
  • Total interest to be paid over loan period is now Rs.30,31,103.47 instead of Rs.51,64,304.67.  That means you saved Rs. 21,33,201.21.
  • Total amount paid over the loan period (Principal + Interest) is now Rs.90,31,103.47 instead of Rs.1,11,64,304.67. You saved Rs.21,33,201.21.
Now its your turn to find out prepayment of loan benefit for you by downloading the calculator.
Prepayment of loan

What are prepayment charges?

Banks incur a losses due to prepayment as they have to foregone interest payment. Since any early payment of loan will reduce the principal amount of loan on which interest is calculated (for clarity you have prepayment calculator). This is the reasons many banks have charges for foreclosure or prepayment of loan. You can refer to terms and conditions related to your loan provided by banks or financial institutions.  

For clarity we are providing you a link for the terms and conditions of personal loan by HDFC Bank: Click here and check prepayment charges. Also some banks do not accept prepayment in starting months. We advise you before closing your loan, have a look on terms and conditions. You also need to do cost and benefit analysis. 

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Is foreclosure of loan good or bad?

  • Now you have an idea that if you close your loan than you can save lot of money for other purposes. This will free you from financial burden.
  • Another benefit with foreclosure of loan is that it will improve your CIBIL score that will help you in getting another loan easily.
  • Your salary will not go for just clearing EMIs rather an enjoyable future.

Does a loan affect your tax return?

Tax benefits on home loan are summarized as follows

  • Under Section 24(b): Maximum tax deductible amount that can be claimed on Interest payment is Rs 2,00,000.
  • Under Section 80C: Maximum tax deductible amount that can be claimed on Principal payment is Rs 1,50,000.
  • Under Section 80EE: Maximum tax deductible amount that can be claimed on additional interest payment (for first-time buyers) is Rs 50,000.

Tax benefit on education loan are summarized as follows:

  • Under Section 80C: Maximum tax deductible amount that can be claimed on interest payment is Rs 1,50,000.
  •  This benefit is available for first eight years only from the year repayment of education loan has started.
So before deciding closure of loan, you need to take this into consideration as well.  Still benefits of closure is quite high and if you cannot pay in full then pay in parts on receiving of any large amount from any source like bonus etc. 
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