Prepayment of Car loans

While taking any of the loans, we always opt for a well-planned repayment schedule depending on our present financial conditions. However, sometimes we may find ourselves with an unexpected windfall in our salary and decide to close our existing loans by availing prepayment. Remember, prepaying your loan has many advantages, but you may be levied with certain charges for doing so. So, before you decide to prepay your car loan, you need to analyze how this decision can impact you in the long run, especially in terms of financial gains. Additionally, you need to have a good understanding of the calculations involved in the prepayment of a car loan to reach an informed decision in this regard. Here you can find more about car loan prepayment and its impact on your finances.

Different types of car loan prepayment

Part prepayment: When you are paying off a part of your car loan by making larger payments than the EMI, before the end of the loan tenure, it is known as a part prepayment. By this, your principal outstanding and EMI amount will be reduced significantly.

Full prepayment/Foreclosure: When you are paying off your loan completely before the end of tenure, it is called full prepayment. 

Note: Some banks do not allow prepayment in parts for car loans. Also, make sure that you are informed about the new repayment schedule after you do a part prepayment.

Benefits of a car loan prepayment

The biggest benefit of prepaying your car loan is that you can easily clear off the debt and you do not have to worry about making your monthly EMI payments. Once you pay off your car loan in full, you get the ownership of the vehicle.

Remember, when it comes to car loan prepayment, every lender has its own terms and conditions on it. So, it is best to review the prepayment clause from your respective lender to see if it benefits you, before taking a final move.

The process to calculate car loan prepayment charge

Sometimes, prepayment can work to your advantage and sometimes not. For example, foreclosure of a car loan towards the end of tenure may not be favorable because the prepayment penalty may exceed the interest to be paid towards the loan. If you want to check your prepayment penalty based on the principal outstanding amount, then, you can make use of an online car loan prepayment calculator.

In a car loan prepayment calculator, you will have to enter details like the original loan amount, the start date of the car loan, tenure, rate of interest, and prepayment penalty. Based on the information you have entered, the car loan prepayment calculator will project by how much your principal balance is lowered, the interest savings, and also the number of months by which the repayment term is shortened.

This information will help you make a wise decision when it comes to prepaying a car loan. In short, if the savings on interest are greater than the penalty, you can proceed with your car loan foreclosure.

Car loan prepayment penalty

If the borrower pays the loan amount in full before the end of the loan tenure, a small penalty is charged by the bank. This is because the lender does not get the anticipated interest and this charged penalty acts as a compensation. The car loan foreclosure penalty amount depends on the principal outstanding, interest outstanding and at what point of the tenure the loan is being paid off.

Prepayment and pre-closure could mean differently when it comes to penalty charges. Prepayments can be done in parts or in full and pre-closure or foreclosure means the entire loan is paid before the tenure ends. It is important that you are well-informed about the prepayment clauses and penalty charges before applying for a loan with your bank.

Provisions for prepayment

Most of the banks discourage prepayment as it would deprive them of earnings in terms of interest on the car loan, which usually goes up to 14% or more. Generally, these are the prepayment conditions that most banks usually put forth (these may vary from bank to bank):

For fixed interest car loans, the prepayment penalty of up to 3-5% is levied for private financiers and 2% for public sector banks. Additionally, service taxes are also applicable.

For floating rate car loans, there are no prepayment penalties charged as per the RBI's directives. So, one can prepay and transfer the loan to another bank that is offering a lower rate of interest as compared to the existing loan. Most of the banks do not permit prepayment during the first six months of the repayment tenure.

Important points to keep in mind before pre-paying your car loan

There are a few things that every borrower should know while pre-paying their car loans

Prepayment lock-in period: Most banks have a lock-in period ranging from 1 to 3 years, during which borrowers are not allowed to pre-pay their loan. However, floating-rate loans have no lock-ins as per the guidelines issued by the RBI.

Prepayment penalty: A penalty is charged for pre-paying your loan before the end of the lock-in period. These charges vary from one financial institution to another, and often, even from loan to loan. So, it is important for the borrowers to check and read their loan contract.

Interest rate of loan: The interest component of the loan is calculated on the reducing balance method by most banks. This means that the interest component is higher during the beginning and reduces as the tenure decreases. While prepaying your loan, you can make use of a pre-payment calculator, it will help you to find out the exact interest you can save by following a pre-payment plan.

When should you prepay your car loan?

If you have sufficient funds to prepay and have no plans of using it for any other purpose, in that case, you can consider prepaying your car loan. However, you should make sure that before choosing this option, you must clear all the other debts that may have higher interest rates. Consider the impact of prepayment charges as well, if any. 

If in the case you are planning to sell your car, you may have to foreclose the loan to transfer the ownership of the same. Some banks allow you to transfer the loan along with the ownership, provided that the new owner is creditworthy. So, you need to check this with your lender before going for this.