Personal loans are undoubtedly one of the best instruments for resolving financial constraints and achieving major milestones in life. Since these loans don’t need collateral from borrowers, they are naturally quite popular.
At times, borrowers prefer to pre-pay the loan ahead of time and get the burden off their shoulders. Many also do this if they are planning to take another loan and don’t want to service two loans at a time. Are you wondering if prepayment is a viable option for you? Will it affect your credit score? If yes, how?
Let us take a look at how pre-paying your loan impacts your credit score.
Things to consider before you prepay
Personal loan pre-payment can reduce your debt-to-income (DTI) ratio since your debt obligations will reduce. This is advantageous for you if you are planning to take on another loan after prepaying your current one. The lower your DTI, the higher are your loan approval chances. Thus, if you’d applied for the loan for emergency funds, and are now able to re-pay, you can consider pre-payment.
While repaying your loan early can relieve you of the loan burden, exhausting your savings to do this can prove risky. It will definitely affect your ability to tackle any unforeseen financial emergencies. However, if you have ample savings with left even after pre-payment, you can think about it. But, if your savings are slim, personal loan repayment before the due date is not advisable.
Additional Read: Things you need to Know about Personal Loan Prepayment Option
Impact of prepayment on credit score
If making timely payments towards your loan spells good news for your credit score, then the same logic should apply to paying your loan off early, right? Unfortunately, it does not work that way.
Paying off a loan is much different from clearing the dues of credit cards and paying EMIs. When you clear off a loan completely, your credit report indicates a closed account. However, when calculating your credit score, credit rating bureaus take your open accounts into consideration.
Effective management of the finances of the open accounts has a more significant impact on credit scores than the ones closed early. This is because open accounts are indicative of your present and past debt history. While timely and regular payments on closed loans form a crucial part of your credit history, the personal loan impact on credit score is not too significant. It is worth remembering that this logic does not apply to credit card repayments. An active credit card account is always considered an open account. Thus, even when the balance is full and untouched, your credit line stays intact.
Additional Read: Is personal loan pre-closure advisable?
If you do have the funds to pre-pay your loan, it is something you can consider. Whether you decide on paying off your loan early or not, it is vital to choose an established lender like Tata Capital. Come to us for attractive personal loan interest rates, flexible terms, and minimal documentation.
What’s holding you back? Reach out to us right away and enjoy reliable lending solutions at Tata Capital!