By Rishi Mehra | 25 Jun, 2015, 10.21AM IST | Economic Times

Personal loan has been a very popular product in the country because of the flexibility it brings in. Often taken to tide over a temporary shortfall in money, personal loans are taken for weddings, to buy consumer durable, medical emergencies, vacation and to fulfill many other needs.

While interest rates on a personal loan continue to be the single biggest factor in deciding which bank to take a loan from, another important factor in deciding the bank is on prepayment provisions. Since many take a personal loan to repay it back before the stipulated tenure, prepayment policies around a personal loan are important. Also, personal loans are a form of “bad loans” and often do little to increase your asset or improve your financial position. Hence, it makes sense to repay the loan if possible. In such a case, prepayment policies play a vital role in choosing the bank.

There are generally four reasons to prepay a personal loan:

The amount is less – Many choose a full payoff of the loan when the principal amount left is relatively small and the borrower wants to save on whatever interest he can by paying off the loan early. Full payoff generally happens when the loan has been serviced for a considerable period of time and the remaining loan balance is small.

Refinancing – A prepayment also happens when the borrower decides to switch banks to take advantage of a lower interest rate. Personal loans often carry very high interest rates and borrowers often switch banks to refinance their loans at a much lower interest rate. Once the lock in period (generally a year) is over, a large percentage of borrowers refinance their loans. In such cases prepayment provisions are very important.

Increase in Salary – When a personal loan is first taken, a borrower’s financial condition can be quite different from what it is say two years down the line. An increase in salary or a bonus may lead to greater cash in hand. Keeping such eventualities in mind, it may make sense to factor in provisions of prepayment for the personal loan before taking one.

No Tax Savings – Unlike a home loan that helps a borrower save taxes, there is no such provision when it comes to a personal loan. In such a case it makes sense for a borrower to look to prepay off the loan and save on the high interest outgo. Coupled with the fact that personal loan, often does not lead to an increase in asset, looking to prepay the loan is a very important factor when choosing a bank.

The logic:

People tend to prepay personal loans, especially since the interest rates on the product are significantly higher. Interest rates on personal loans often range anywhere between 12 %- 26 % and borrowers look at paying off this loan before they look to tackle any other credit. Also, since the amount in questions is significantly lower, unlike a home loan, it is possible for a borrower to, perhaps, save and prepay the loan. For a shorter time frame, even a few thousand can be a significant savings generated out of prepaying the loan.

The personal loan prepayment is also a relevant factor since it is easier to refinance a personal loan since there are very less documents involved. Unlike a home loan where the property documents are with the bank that has originally extended the loan, a personal loan has no such documents with the bank and is relatively easy to be refinanced.

What a borrower must look at before taking a personal loan that he intends to prepay is whether it has a prepayment fee tied to it. Banks often charge this rate because they have to forego the interest that they would have got if the borrower would have stuck to the agreed loan agreement. Some banks in India have a prepayment fee and as a borrower it is very important to find out if the benefit of prepaying is more than the fee you have to pay.

Bank Prepayment Charges: ICICI Nil (For Loan amount >10 lakh & 12 EMI paid), else 5% HDFC Nil (For Loan Amount > 10lakh with >Salary 75k) else 4% Bajaj Finserve Nil Tata Capital Part Prepayment with ZERO Charges SBI Nil Kotak Mahindra 0% – 5% Fullerton India Zero after 3yrs (Otherwise 4%) Axis Bank Nil

Personal loans are relatively easy to understand when it comes to their terms and conditions. While rate of interest is the most important factor when choosing a bank, the often neglected, but equally important factor is prepayment provisions of the lender.

(The author is co-founder deal4loans.com, which is a platform for online comparison for retail loans in India. Views expressed are personal)

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