Whenever one seeks a loan there are certain factors that attract a lot of attention, regardless of the type of loan it is. Interest rates is one such aspect, this is what one focuses on the maximum as it is the biggest cost that is associated with a loan. Borrowers may also find out details about other costs like the processing cost and so. However another cost that may arise in the course of the loan tenure, the pre-payment cost is often ignored. Here we discuss in detail about the prepayment cost and why it should not be ignored.
Understanding Car Loan Pre-payment:
Loans are taken for fixed terms as defined in the loan agreement. EMIs are decided based on the loan amount term and the interest rate. However if the borrower has some spare funds he/she might want to pre-pay (pay before the end of the term) a part of the loan or the entire amount due. This is known as pre-payment, it may be partial when only a part of the outstanding amount is paid or it may be full when the entire loan amount is paid before the loan tenure ends. When the entire amount due is repaid by the borrower it is known as foreclosure.
Prepaying a Car Loan: Charges
The borrower may assume that prepaying a loan would be a good thing as they would save their interest cost and the lender would also be happy to receive the amount earlier than anticipated, however this is not the case. Based on the loan amount, car loan interest rate and the tenure the lender anticipates certain cash flows over a time period, so when the borrower repays the entire amount or a part of the amount earlier than expected then the lender faces loss of interest for the said period. To compensate for this loss in revenue the lender may charge a pre payment penalty. This penalty may also be a tool to dissuade the borrower from prepaying a loan.
All lenders may have different rules regarding prepayment. Some may allow pre payment only after a certain time period has elapsed and the charges also vary from one lender to another. It is important that before signing your loan agreement you get clarity on the charges and also the conditions related to loan prepayment. This will save you from getting a rude shock when you decide to pre pay a loan and will also help you in making an informed decision when planning to prepay a loan
Should You Prepay a Car Loan?
This decision will depend on a variety of factors, the first being the cost of prepaying a loan versus the savings. Prepaying a loan involves certain cost (prepayment penalty charged by the lender) and when you prepay a loan you save some amount on the interest. It is important that a cost benefit analysis is done before reaching a decision.
Also factor in the opportunity cost, if you do not use the spare funds to prepay your loan you could invest this amount elsewhere which would get you returns. Compare the savings made by prepaying the loan with the interest that you would have earned by investing it elsewhere before reaching a decision on prepayment. Another aspect to keep in mind is that foreclosure will impact your credit score negatively in the short term. Details about all loans are mentioned in the CIBIL Report and the details about foreclosure will also be included in it.
Getting a new vehicle is pretty exciting but it’s essential that when you are seeking a loan for buying you find out about all the nitty-gritty that goes into the loan agreement including the pre payment penalty.