Last Updated on January 21, 2025 by Caesar
Last year, Rahul, a software engineer, received an unexpected bonus. With a lump sum in hand, he decided to repay his ₹10 lakh personal loan early. He thought this would increase his credit score instantly.
To his surprise, the results weren’t exactly as he had imagined. Early loan repayment, while financially freeing, can have complex effects on your credit score.
Data from TransUnion CIBIL indicates an improvement in India’s credit culture, with the share of prime-rated borrowers (credit scores above 731) rising from 51% in June 2022 to 55% by June 2024.
Let’s explore how it works and what you need to know.
What Happens When You Pay Off a Loan Early?
Imagine you’ve borrowed ₹ 10 lakh at 12% interest for five years. Your EMI would be approximately ₹ 22,244. Over the tenure, you’d pay ₹ 13,34,640, of which ₹ 3,34,640 is interest. Now, let’s say you repay the loan after two years instead of five. You save ₹1,47,840 in interest. Sounds great, right?
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But here’s the catch: While you save on interest, your credit history might shrink. Why? Lenders look at the length of your credit history and repayment consistency. Early repayment ends that loan’s contribution to your track record sooner than planned.
Positive Effects of Early Loan Repayment
Paying off a loan early has its perks:
- Reduced debt burden: It lowers your overall liabilities, leaving room for other financial goals.
- Improved financial stability: You no longer worry about monthly EMIs eating into your cash flow.
- Better chances for new loans: Lenders might view you as a low-risk borrower.
Here’s a table showing the difference in interest paid for early vs. full-term repayment:
Loan Amount | Interest Rate | Tenure | EMI (₹) | Interest Paid (Full Term) | Interest Saved (Early Repayment) |
₹10,00,000 | 12% | 5 years | ₹22,244 | ₹3,34,640 | ₹1,47,840 |
The financial benefit is clear, but let’s not forget the potential credit score impact.
Negative Effects of Early Loan Repayment
Early repayment isn’t always credit-score friendly. Here’s why:
- Shorter credit history: A long credit history shows stability. Closing a loan early might reduce this length.
- Lower credit mix: Loans diversify your credit profile. If this is your only loan, closing it may weaken your mix.
- Lost repayment record: Timely EMI payments boost your credit score over time. Early closure stops this positive trend.
Should You Always Repay Loans Early?
Early repayment isn’t one-size-fits-all. Before deciding, ask yourself:
- Does your loan have a prepayment penalty? Some banks charge 2-3% of the outstanding balance, wiping out potential savings.
- Are you planning to take another loan soon? A short credit history might reduce approval chances.
- Do you have an emergency fund? Repaying early might leave you cash-strapped during a crisis.
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Practical Tips to Manage Early Loan Repayment
Consider these scenarios before leaping:
- If your loan has just started, most of your EMI goes towards interest. Repayment saves more in this stage.
- If you’re closer to the end of the tenure, interest savings will be minimal. In this case, investing the money might yield better returns.
- Use a prepayment calculator to estimate your savings accurately. For instance, on a ₹10 lakh personal loan with 12% interest and 5-year tenure, repaying ₹5 lakh after two years saves you ₹73,920 in interest.
Conclusion
Paying off a ₹10 lakh personal loan early can feel liberating. However, it’s important to evaluate how it affects your credit profile.
A thoughtful approach like balancing interest savings, credit score impact, and financial stability can help you make the right choice. Remember, the goal isn’t just to save money today but to secure your financial future.
FAQs
1. Does early loan repayment always lower your credit score?
Not always. It can lower your score if it shortens your credit history or reduces your credit mix.
2. Should I repay a personal loan early if there’s a prepayment penalty?
Only if the savings in interest outweigh the penalty amount.
3. How soon will my credit score reflect early repayment?
Changes in your credit score typically show up within 30-45 days.
4. Can early repayment impact my ability to get another loan?
Yes, a shorter credit history might make you less attractive to lenders.