All borrowers who aspire to close their personal loan accounts before the end of the originally decided tenure can do the same by following a structural procedure. The Reserve Bank of India (RBI) has also reiterated that lenders must clearly communicate and elaborate the prepayment requirements, charges and documentation needs with the borrowers to make the entire process transparent and hassle free for the borrowers.
What is loan foreclosure?
Foreclosure refers to the full repayment of a loan before its due date as per the contractual obligations entered between the borrower and the lender. This can help in ensuring that the borrowers save on interest payments over time.
Still, depending on the terms and conditions of the loan product availed along with the lender, foreclosure charges may apply. It is especially important for fixed rate loans. Borrowers in their own interest are suggested to check the terms and conditions of their loan agreements or visit their respective lenders official website for detailed information on the stipulations, terms and conditions.
Is foreclosing a loan good or bad for your credit score?
When you are going ahead with foreclosing a personal loan it has a mixed impact on your credit score:
- Positive impact: It depicts strong repayment capacity and reduces your credit burden.
- Neutral/Negative impact: On the negative side, it can slightly reduce your credit mix and average credit age, especially if it is your only active loan or credit card. That is why, if you have other active credit lines, foreclosure is generally favourable.
Foreclosure charges you should know
Financial institutions and lenders may impose foreclosure expenses or prepayment penalties. These charges generally range from 2% to 5% of the outstanding principal. Furthermore, these charges vary based on:
- Type of loan availed i.e., fixed vs floating interest.
- Total time requested for foreclosure (post six or twelve EMIs or earlier).
- Independent policies, terms and conditions of respective lenders (NBFCs generally charge more than banks).
That is why you should always refer to your loan agreement and the official website of the lender for complete clarity on these fundamental issues. Not only this, if in doubt always discuss your problems with the dedicated customer service team of your lender.
Benefits of loan foreclosure
- Planned foreclosure assists in saving interest payments.
- It helps in boosting your debt to income ratio.
- Improves future loan eligibility.
- Removes debt hence provides financial freedom.
Disadvantages of foreclosing a loan
- Foreclosure charges can impact finances and offset savings,
- Possibility of a drop in credit score due to a shorter credit history.
- Might even result in loss of tax benefits, if any.
- Issues related to liquidity, if you use emergency funds to foreclose.
Step-by-step foreclosure process
To foreclose a personal loan, borrowers must:
- Inform the lender of their intention to foreclose the loan, either online or in writing.
- Request a foreclosure statement from the lender.
- Pay the outstanding principal along with any applicable foreclosure charges.
- Submit KYC documents such as PAN card and Aadhaar for identity verification.
- Collect a ‘No Dues Certificate’ or loan closure letter from the lender.
Borrowers can usually initiate this process through the lender’s mobile application, net banking portal, or by visiting the dedicated branch of your respective bank or lending institution.
RBI’s stance on foreclosure transparency
The Reserve Bank of India i.e., RBI has directed financial institutions to clearly disclose all prepayment and foreclosure charges upfront and keep nothing hidden from the borrowers. To protect the rights of the borrowers they must not face any hidden charges or costs.
They should also not be subjected to any unfair restrictions during early loan closure. With personal loans rising 14% YoY in early 2025, especially among the youth i.e., younger borrowers, clearly understanding foreclosure concepts and terms is more important than ever.
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