Personal loans are one of the most popular borrowing options for individuals in India. Whether it’s for medical expenses, weddings, education, or home renovations, personal loans offer quick access to funds with minimal documentation. Once you take a loan, you face two repayment choices: Should you foreclose the loan early, paying off the remaining balance at once? Or should you stick to the regular EMI payments until the end of the loan tenure and use the lump sum amount for an investment?

This blog will help you understand personal loan foreclosure vs. regular EMI payments, their benefits and drawbacks, and when each option makes sense.

What is Personal Loan Foreclosure?

Foreclosure of a personal loan means repaying the entire outstanding loan balance at once before the end of the loan tenure. Borrowers usually choose to foreclose their loan when they get some extra money, like a bonus, returns from investments, or other savings.

Foreclosure Penalties:

• Many lenders (Banks and NBFCs) charge a 2% to 5% prepayment fee on the outstanding personal loan amount. Although some lenders waive off penalties, only if you have paid a specified number of EMIs (usually 6 to 12).

Benefits of Personal Loan Foreclosure

1. Interest Savings: Paying off your loan early helps you save money on interest. For example, if you foreclose a personal loan two years before the tenure completes, considering the loan amount is ₹5 lakh, the rate of interest is 16%, and the total tenure is 5 years. You can save around ₹43,000 in interest.
2. Debt-Free Lifestyle: Zero financial obligations lead to peace of mind and improved cash flow.
3. Improved Credit Score: Loan foreclosure positively impacts your credit report and credit score as it improves your debt-to-income ratio.

Also Read: Top factors that affect your credit score?

What are Regular EMI Payments?

EMI (Equated Monthly Instalment) is a fixed monthly payment that covers your loan’s principal and interest components.

How EMIs Work:

• EMIs are calculated using the reducing balance method, meaning interest is calculated monthly on the remaining loan amount, not the entire loan amount.
• Your EMI amount stays the same monthly, but initially in the repayment tenure, you pay more interest and less of the loan amount. Over time, the interest component decreases while the principal component increases in the EMI amount.

Benefits of Continuing Regular EMI Payments

1. Opportunity for Investment: Instead of using a lump sum amount to foreclose a loan, you can invest in assets like mutual funds, stocks, fixed deposits, etc
2. Better Liquidity: Maintain an emergency fund rather than using the entire funds for prepayment.
3. Avoid Prepayment Penalties: Some lenders charge prepayment fees, making foreclosure less attractive.
4. Tax Benefits: Ongoing EMI payments may provide tax benefits under Section 24 (b) and Section 80E if you use the personal loan amount for home construction or Education.

Also read: Tax benefits on personal loans

Benefits of Investing Instead of Foreclosing Personal Loans

Investing your lump sum instead of foreclosing your personal loan may initially seem risky. Still, it offers the opportunity for higher returns than the interest savings from paying off the loan early. Here’s a deeper look at how different investment options could benefit you:

• Equity Investments (Stocks, Mutual Funds): According to Moneycontrol, large-cap equity mutual funds have delivered an average annual return of 10-12% over the last decade. While it involves risk, long-term investments in stocks or equity mutual funds could potentially outpace the savings from loan prepayment, especially if the loan’s interest rate is lower than this potential return.
• Debt Mutual Funds and Fixed Deposits (FDs): These are less risky compared to equities and provide more predictable returns. Debt funds typically deliver returns between 7-9% annually, and fixed deposits offer annual interest rates between 5% to 7%. While the returns are lower than equities, they still provide liquidity options, compared to foreclosing a loan with your money and having nothing in hand when needed.  
• Real Estate Investment: In India, the average annual return on real estate investments is 10%. However, real estate requires more upfront capital, and liquidity is lower than in other investment options.

The Power of Compounding: Why It Matters

One of the advantages of investing a lump sum amount instead of using it to foreclose a personal loan is the power of compounding. Compounding allows you to earn returns on your initial investment and the accumulated interest.

For example, following the above example, instead of foreclosing the loan two years before the 5-year tenure ends, if you invest ₹ 2,91000 in a mutual fund with an average return of 11% annually. With annual compounding, your investment would grow to ₹3,62000 in 2 years, even without additional contributions. You will earn an interest of ₹ 71,245.

Scenarios: When Should You Consider Foreclosure vs EMI Payments?

Scenario	Foreclosure Makes Sense	EMI Payments are Better
Loan Interest Rate	High	Low or moderate interest rates
Investment Opportunities	No better investment options are available	Available investments with better returns (12% or higher)
Cash Flow Flexibility	Stable income and surplus funds	Need to maintain liquidity for other financial goals
Prepayment Penalties	Minimal or waived after 6-12 EMIs	High prepayment penalties
Goal	Aim to be debt-free earlier, reduce liabilities	Prefer to build wealth through investments

Choosing between personal loan foreclosure and regular EMI payments depends on your individual financial goals, the loan terms, and available investment opportunities. Always evaluate the loan’s prepayment benefits, penalties, and opportunity costs before making a decision. Use a loan prepayment calculator to understand your savings. For personalised advice, consult a financial planner.

Frequently Asked Questions (FAQs)

1. What is personal loan foreclosure?

Personal loan foreclosure refers to the early repayment of the entire loan amount, including the principal and accumulated interest, before the loan’s tenure ends.

2. Which is better: Foreclosing a personal loan or paying through EMIs?

Loan foreclosure can save you money on interest, especially if the interest rate is high. However, it may come with penalties, and not everyone may have the available funds to make an early repayment. Paying through EMIs, on the other hand, allows you to manage your cash flow while making gradual payments; however, you’ll end up paying more in interest over time.

3. What are the penalties for foreclosing a personal loan before the tenure ends?

The loan foreclosure penalty amount can vary, but typically ranges between 2% and 5% of the outstanding loan amount. However, some lenders may offer no foreclosure charges after a specified period of repayment, such as six months or a year.

4. Can I foreclose my personal loan anytime?

Your loan agreement determines when you can foreclose. Most lenders allow loan foreclosure after a specific period (e.g., 6 months or 1 year of loan repayment).

5. Are there any tax benefits for foreclosing a personal loan early?

Generally, there are no direct tax benefits for foreclosing a personal loan early. Unlike home loans, personal loans do not qualify for tax deductions on interest payments.