How Pre-Closure Of Personal Loan Can Impact Your Credit Score

Personal loans offer a convenient way to address immediate financial needs. However, repaying a loan before its scheduled end date—known as pre-closure—is an option many borrowers consider to save on interest costs. While the pre-closure of a personal loan might seem like a financially savvy move, it's important to understand how it can impact your credit score. Does pre-closure of loan affect CIBIL score? Let's explore this question in detail while unpacking the benefits and considerations of pre-closure.

What is Pre-Closure of Personal Loan?

Pre-closure of a personal loan refers to repaying the outstanding loan amount in full before the tenure ends. Borrowers often opt for this when they have surplus funds or want to reduce their debt burden. While it helps save on interest payments, pre-closure may involve certain charges or penalties imposed by the lender.

Does Pre-Closure of Loan Affect CIBIL Score?

The effect of pre-closure on your CIBIL score (or credit score) depends on various factors. Let's break it down:

Positive Impact

1. Debt Reduction: Paying off your loan in full reduces your overall debt burden, which is a key factor in your credit score. A lower debt-to-income ratio reflects positively on your financial health.
2. Timely Closure: If you pre-close your loan after consistent and timely repayments for a significant period, it demonstrates financial discipline, which can positively influence your CIBIL score.

Potential Negative Impact

1. Short Credit History: Pre-closing a loan prematurely can shorten your credit history, especially if it's your first loan. A longer credit history is generally beneficial for your CIBIL score.
2. Missed Opportunities for Positive Credit Behaviour: Regularly repaying EMIs over the tenure contributes to a consistent track record, which helps build your credit profile. By pre-closing, you might miss out on this opportunity.

Also Read: Steps to Check Your CIBIL Score Using Your PAN Card

Key Considerations Before Opting for Pre-Closure

1. Pre-Closure Charges

Lenders often impose a pre-closure fee, which can range from 2% to 5% of the outstanding amount. Calculate whether the savings on interest outweigh these charges before deciding.

2. Impact on Credit Mix

Having a mix of credit types (secured and unsecured) is good for your credit profile. Pre-closure of a personal loan might impact your credit mix, especially if you don't have other active loans.

3. Credit Utilisation Ratio

Pre-closure reduces credit utilisation, which is generally a positive factor. However, to ensure this benefit, it's essential to maintain other forms of credit responsibly.

4. Financial Stability

Ensure that pre-closing the loan doesn't drain your savings or leave you financially vulnerable. Retaining an emergency fund is crucial.

Benefits of Pre-Closure of Loan

1. Interest Savings

The primary benefit of pre-closure is saving on the total interest payable. The earlier you close the loan, the more you save.

2. Improved Financial Flexibility

Eliminating EMIs frees up your monthly budget, allowing you to allocate funds toward other financial goals.

3. Reduced Debt Burden

Pre-closure lowers your overall liabilities, which is advantageous when planning for significant future expenses or loans.

How to Pre-Close a Personal Loan

1. Check Pre-Closure Terms

Review the loan agreement for pre-closure policies, including charges and conditions.

2. Calculate the Total Cost

Compare the savings on interest with the pre-closure fee to ensure it's a financially sound decision.

3. Notify the Lender

Inform your lender of your intention to pre-close the loan. They will guide you through the process and provide the outstanding amount.

4. Make the Payment

Pay the outstanding amount as per the lender's instructions. Obtain a no-dues certificate to confirm the loan closure.

5. Check the Credit Report

Verify that your credit report marks the loan account as closed. Any discrepancies can negatively impact your CIBIL score.

Does Pre-Closure Always Make Sense?

Pre-closure isn't always the best option. Here's when it makes sense and when it doesn't:

When to Pre-Close

1. You have sufficient surplus funds. 2. The remaining tenure is long, resulting in substantial interest savings. 3. The pre-closure charges are minimal.

When to Avoid Pre-Closure

1. The pre-closure fee exceeds the interest savings. 2. You have other high-interest debts to pay off first. 3. It significantly impacts your savings or emergency fund.

Tips to Manage Pre-Closure Effectively

1. Build a Strong Credit History First

If it's your first loan, consider repaying as per the schedule for a while to build a solid credit history before opting for pre-closure.

2. Time the Pre-Closure Wisely

Pre-closing during the initial years of the loan tenure saves more on interest since interest payments are higher in the early stages of repayment.

3. Clear Other Debts First

Prioritise clearing high-interest debts like credit card dues before pre-closing a personal loan.

4. Maintain Other Active Credit

To mitigate the impact on your credit mix and history, ensure you responsibly maintain other active credit accounts.

Summing Up

Pre-closure of a personal loan offers significant advantages, including reduced debt and interest savings. However, understanding how pre-closure impacts your credit score is essential to make an informed decision. While it can improve your credit profile by lowering debt obligations, it might also affect your credit history and mix.

Does pre-closure of loan affect CIBIL score? The answer depends on your overall financial behaviour and loan management. Before opting for pre-closure, evaluate your financial goals, obligations, and the costs involved. By managing your loans responsibly, you can enjoy the benefits of financial freedom while maintaining a healthy credit score.