Interest for a personal loan is generally calculated on the outstanding principal balance during the loan tenure. Making part-payments or paying a lump-sum amount over and above the scheduled EMIs reduces the principal balance sooner than planned. Since interest is calculated on the remaining principal, this early reduction results in a lower personal loan interest rate over the life of the loan.
Simply put, if you make part payments during the loan tenure, the interest amount reduces as the principal does. This allows the borrower to repay the loan sooner and reduces the loan’s long-term cost. In this article, we will shed more light on personal loan part payments.
What does a part-payment mean
Part-payment, also known as partial prepayment, refers to paying a sum towards the principal amount before the scheduled repayment timeline ends, while still keeping the loan active and continuing EMIs. This extra payment is separate from the regular monthly instalments.
Part-payments are different from full prepayment or foreclosure, which involve repaying the entire outstanding amount at once.
How part-payment reduces total interest
Typically, interest is only calculated on outstanding principal. When a partial payment reduces the principal, the interest on future EMIs also decreases. Here are some ways that reduce part-payment interest outgo:
- Lower principal balance: Interest is calculated on a reduced principal amount after a partial payment
- Reduced overall interest paid: The overall cost of total interest paid decreases over time
- Option to reduce tenure or EMI: Borrowers may choose to shorten the loan tenure or reduce the EMI, as per the lender’s policies
Although the personal loan interest rate remains intact, the total interest paid decreases because the principal is reduced earlier.
Timing matters when making part-payments
The impact of part-payments on interest savings depends on when they are made. Payments made earlier in the loan tenure generally lead to higher savings, as the principal is reduced when interest rates are higher.
It is important to review your loan account statement to check whether your lender allows part-payments, and whether there are any penalties or charges. Also check for regulations such as minimum time elapsed or limits on the number or number of part-payments allowed in a year or the entire tenure.
Using an EMI calculator to plan repayments
Applicants can use an EMI calculator to understand how part payments affect loan repayments. These digital tools allow borrowers to estimate EMIs for different loan amounts and tenures. It helps by:
- Estimate monthly EMIs
- Compare repayment scenarios after making a partial payment
- Evaluate how reducing tenure reduces the overall interest paid
Using an EMI calculator allows borrowers to make informed decisions that align with their repayment capacity and reduce their overall loan cost.
Things to consider before making a part-payment
Before making a part-payment on a personal loan, borrowers must review the loan agreement and have a good understanding of the lender’s repayment and foreclosure policies.
Key factors to consider before making part-payments are:
- Minimum waiting period before opting to make a part payment
- Any processing fee, part payment penalty or other associated costs
- Maximum number of part-payments allowed in a year
Reviewing these policies helps the borrower make sound repayment decisions that align well with their financial goals.
In summary
Part-payment can be an effective strategy for borrowers who want to reduce the overall interest outgo on a personal loan. By lowering the principal earlier than scheduled, borrowers reduce the amount on which interest is calculated, making the loan cheaper.
You can use an EMI calculator to check different tenures and loan amounts to get an estimate of how much the interest will cost you. It will also give you an insight into how to plan your finances for the future.
CAclubindia
