All loans are governed by a few conditions that are agreed on to by both the lender and the borrower at the time of taking the loan. These pertain to the amount to be borrowed, interest rate that is to be charged, mode and frequency of repayment and the loan tenure. There are few other conditions also that lay out what happens if the borrower defaults on the payment, what are the additional charges and what if the customer wants to prepay the borrowed amount and so on.
Prepaying a Car Loan: Understanding the Fine Print
One might assume that prepaying a loan is a good thing; if somebody borrowed money from you and decides to return it earlier then they intended initially then you would be happy. Right? However this is not the case with banks or NBFCs. All organized lenders when extending a loan work out the cash flows that would occur to them over the loan duration. So when the borrower prepays a loan this calculation goes awry and there is interest loss too that the lender suffers. When a loan is prepaid partially or fully, interest that would have been paid on the unpaid borrowed amount would reduce or cease to flow altogether for the lender thereby causing loss on to them. Thus lenders try to discourage borrowers from pre-paying the loan.
Any borrower before deciding to prepay any loan should try and work out the cost that would incur to him or her for repaying it and the benefit that would arise out of the prepayment. The decision to pre-pay should be based on a comparison between the cost and benefit that would occur when a car loan is prepaid. The borrower should not forget to factor in the impact that prepayment has on the credit score. Any loan that completes the full loan tenure is better for the credit score rather than a loan that is prepaid.
Conditions that do not hamper Prepaying a Car Loan:
As we said earlier lenders would generally try and discourage a borrower from prepaying a loan. Below we discuss a few conditions that do not hamper prepaying a car loan. Some banks have no penalty on prepaying a loan whatsoever, so in such scenario the opportunity cost of prepaying a car loan will be the main consideration for the borrower.For a floating rate loan there is no penalty at all for foreclosing a loan so the borrower need not worry in such a case. If someone is looking at making a full prepayment or foreclosing a loan then some banks may allow it after a certain period of time without charging any penalty. ICICI Bank car loan is such an example; if the foreclosure is made 18 months after the taking the loan by a salaried individual and 24 months after the loan disbursal by a self-employed then no charges are levied. If a payment is made before the given time period then a penalty of 5% of the outstanding amount is charged so the borrower should wait and repay after 18 or 24 months as the case may be. IDBI does not charge any pre-payment penalty if the payment is made after six months of taking the loan, here again the borrower can wait for 6 months to get over before deciding to repay.
Prepaying a loan is based on many factors like the savings versus the cost of prepaying if any, actual savings that would be made, opportunity cost of investing the funds that would be used for prepaying a loan and so on. The conditions laid down by the lender are also an important factor when making this decision.
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