Myths About Prepaying Personal Loans and Their Effects
Myths About Prepaying Personal Loans and Their Effects
Imagine this: you’ve just taken a personal loan. At first, the EMIs don’t sting much—they quietly leave your account every month, and life goes on. But a few months later, you land a salary hike, a bonus, or maybe you’ve built up some savings. Suddenly, a thought pops into your head: “Why not prepay the loan and get rid of this burden once and for all?”
It sounds heroic, doesn’t it? The idea of slamming the door on debt and walking away free. But here’s the thing—personal loan prepayment is surrounded by more myths than facts. Some people will tell you it’s always a masterstroke. Others swear it can actually hurt you. The truth? It’s somewhere in between.
So, let’s bust these myths and uncover what really happens when you decide to prepay a personal loan.
Myth 1: Prepaying Always Saves You Loads of Money
This is the big one—the myth that keeps most borrowers racing toward prepayment. While it’s true that prepaying can reduce your interest outgo, the timing of it is what really decides the savings.
In the early part of your loan, most of your EMI is gobbled up by interest. Prepay at this stage, and you could save a significant amount. But if you’re nearing the end of your tenure, you’ve already paid most of the interest. At that point, prepayment doesn’t really save much—it’s like pouring water into a glass that’s already nearly empty.
So yes, prepayment saves money, but only if you play the timing game right.
Myth 2: Prepayment Is Free of Cost
Wouldn’t it be lovely if lenders happily allowed you to prepay without charging a dime? Unfortunately, that’s not how the system works. Most banks and NBFCs earn their bread and butter from interest. So, when you try to cut that short, they charge a prepayment penalty, often between 2% and 5% of your outstanding balance.
Here’s the catch: if you save ₹20,000 in interest but end up paying ₹15,000 as a penalty, your actual gain is barely worth the effort. In some cases, you may even lose money. This is why reading the fine print of your loan agreement is non-negotiable.
Myth 3: Prepay Today, Credit Score Jumps Tomorrow
If only life worked that way! Many people believe that once you prepay, their credit score will instantly leap into the 800s. But credit scores aren’t built on single actions—they reflect long-term patterns.
Yes, prepayment shows that you’re financially responsible, and over time, that’s a positive signal. But in the short run, your score might actually dip slightly because closing a loan reduces your credit mix. It’s a little like dieting—you don’t lose 10 kilos overnight, but consistent effort eventually shows results. Prepayment improves your financial story, but it’s a slow burn, not a magic trick.
Myth 4: Using All Your Savings for Prepayment Is the Smartest Move
This one’s risky. Imagine draining your emergency fund to wipe off your loan, and then—bam—your car breaks down or a medical bill arrives. With no savings left, you’re back to borrowing again. Ironically, the debt cycle begins anew.
The smarter move is balance. Yes, prepay when you can, but never at the cost of leaving yourself financially vulnerable. Debt freedom should not come at the expense of your safety net. After all, what’s the point of being loan-free if you’re cash-strapped when life throws a curveball?
Myth 5: Prepayment and Foreclosure Are the Same Thing
Let’s clear up this confusion once and for all. Prepayment means paying an extra chunk—over and above your EMI—to bring down your principal. Foreclosure, however, is closing the entire loan at once by paying off everything you owe.
Both save you interest, but they’re not identical. Prepayment is like chipping away at a mountain, while foreclosure is blasting it down in one go. Which one works best depends on your financial comfort zone.
Myth 6: Prepayment Is the Best Way to Use Extra Money
You’ve just received a hefty work bonus. Should you throw it all at your loan? Not always. If your loan interest is 11% but you’ve got an investment option that offers 15% returns, investing will actually give you more value than prepaying.
This is where opportunity cost comes into play. Money is like a soldier—you want it stationed where it wins the most battles for you. Sometimes, that’s prepayment. Other times, it’s investment. The smart choice is the one that grows your wealth faster, not just the one that feels emotionally satisfying.
Myth 7: The Process Is Too Complicated
This myth keeps many borrowers stuck in hesitation. But prepaying today is simpler than ever. Most lenders let you place a request, pay the amount, sign some paperwork, and collect an acknowledgment letter. It’s not a maze of complications, it’s just a short detour on your financial journey.
The Real Effects of Prepaying Personal Loans
So, what really happens when you prepay? The most obvious effect is the reduction in your overall interest payout. Done early, this can mean big savings. It also shortens your loan tenure, meaning you become debt-free sooner. And let’s not forget the emotional benefit—fewer EMIs equals less stress every month.
But prepayment also has side effects. It can temporarily dent your liquidity if you drain too much from your savings. It might not give your credit score the “instant boost” you expect. And if penalties apply, the benefits can shrink.
The truth? Prepayment is powerful—but only when done strategically.
Here’s the part most borrowers overlook—prepayment isn’t about excitement, it’s about calculation. And that’s where CredBuddha steps in. We don’t just tell you to prepay; we help you decide when and how. Should you foreclose or part-prepay? Should you use surplus cash now or wait for a better time? Should you invest instead? These are the questions we help you answer with clarity.
With CredBuddha, financial freedom isn’t a gamble—it’s a guided journey. We don’t just help you slash EMIs, we make sure every move you make aligns with your bigger financial picture. Because true financial freedom isn’t just about paying off debt, it’s about gaining control. With us by your side, myths vanish, strategies shine, and your money finally starts working for you.
FAQs
Q1. Is it always good to prepay a personal loan?
Not always. Prepayment works best when done early in the loan tenure, as it helps save on interest. If you’re near the end of your loan, the savings may be minimal.
Q2. Does prepaying a personal loan affect my credit score?
Yes, but not instantly. Over time, it shows financial discipline and improves your score. However, in the short term, your score may dip slightly due to reduced credit mix.
Q3. What is the difference between prepayment and foreclosure?
Prepayment means paying an extra amount (part of your outstanding loan) in addition to regular EMIs, while foreclosure means paying off the entire remaining loan amount in one go.
Q4. Do banks charge a penalty for prepayment?
Many lenders do. Prepayment penalties can range between 2% and 5% of the outstanding loan amount. Always check your loan agreement before deciding.
Q5. Should I use my savings to prepay my loan?
Only if you have enough savings left for emergencies. Draining your entire savings for prepayment can leave you financially vulnerable in unexpected situations.
Q6. Which is better: prepayment or investing my surplus money?
It depends. If your loan interest rate is higher than expected investment returns, prepayment makes sense. If investments can yield more than the loan interest, investing is smarter.
Q7. How do I know the best time to prepay my loan?
Generally, the earlier in the loan tenure, the better. That’s when interest outgo is the highest. However, consider your financial goals, savings, and prepayment penalties before deciding.
