Should you pre-pay personal loan or stick to original tenure?

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In need of lumpsum capital in the short-term, people often take personal loan. Personal loans come at higher interest rates. Nobody wants to stay indebted! Borrowers may feel, once they have collected enough money, to pre-pay the loan. But pre-payment may attract a penalty. There could be loan-linked insurance benefits that you may not want to forego. What to do? Should you pre-pay the loan or stick to the original schedule? Money9 Helpline received a similar query:

I availed Rs 5 lakh personal loan from a private bank at 11.75% interest rate. The EMI comes out at Rs 11,000. I have paid 24 EMIs so far till July 2021. The outstanding balance is Rs 3,36,000. I am planning to pay the entire balance in one stroke. Please guide me if this is a wise decision. I am asking this because I have Rs 8 lakh accident insurance, Rs 5 lakh group insurance and Rs 1 lakh universal protection insurance linked to this loan.

– Ajay Dixit

We approached Gaurav Aggarwal – Senior Director, Paisabazaar.com to address the query:

I will suggest you to go ahead with your decision to prepay your personal loan in one go. The interest cost savings of about Rs 64,000 derived through the loan prepayment should be higher than premium cost incurred on buying adequate cover for life, health and accident insurance policies. However, make sure to factor in prepayment or foreclosure charges, if any, charged by your lender while prepaying. Also avoid using your emergency fund and surpluses set aside for short term financial goals for prepaying your personal loan. Doing so may force you to avail costlier loans for dealing with any unforeseen financial exigencies or achieve short term financial goals.

Also, while foreclosing your personal loan will cease the insurance cover provided through the insurance policies linked to your personal loan, the availability of such insurance cover should not influence your decision to prepay your loan.

The insurance covers provided through loan-linked policies are usually aimed at reducing the risk for the lenders and thus, may not be adequate for the borrower himself. Hence, one should always purchase adequate life, health and accident insurance cover over and above the ones available through the employers, loans, bank accounts and/or other financial products.