Foreclosing Your Car Loan: Is It A Good Idea?

Taking out a Car Loan is a common practice for people who can’t really afford their dream car. While applying for a Car Loan may not be a particularly arduous task, you may need to think long and hard about prepaying or foreclosing your Car Loan.

As strange as it may sound, not letting your Car Loan run its course may not be a very good idea even if you happen to have some extra funds on hand.

What is foreclosure of a loan?

When you borrow money from a bank or any individual, the lender specifies the terms and conditions of borrowing, which includes the tenure of the loan. If you decide to repay the loan amount before the actual tenure is completed, it is called a pre-closure or foreclosure of the loan.

When you decide to foreclose a loan, it is usually because you have surplus money to pay off the loan and you don’t want to pay EMIs any longer. This helps in saving money since you no longer need to pay the interest.

However, if you thought you could prepay your Car Loan easily since you happen to have extra funds, remember that not all banks will let you do so. Also, you may have to pay penalty fees for prepaying the Car loan.

Additional Reading: Your Car Loan EMI calculator guide

Pre-Payment Vs Foreclosure: What’s the difference?

For most banks, pre-payment and foreclosure are two different terms and involve different charges. If you make a part payment of your loan in advance, it is called pre-payment. But, if you choose to completely pay off the outstanding amount before the tenure of the loan is completed, it is called pre-closure or foreclosure of the loan.

The charges for both these facilities differ from one bank to another, so before opting for any of them, make sure you are aware of the charges involved.

Additional Reading: Conditions To Prepay Your Car Loan

Here are a couple of reasons why foreclosing your Car Loan may not always be a good idea:

Your Funds Can Be Deployed Elsewhere – Think Again!

Make sure to double-check the rate of interest on your Car Loan before deciding to foreclose it. If you happened to get a good deal on the interest rate, you may be better off investing the surplus funds into equity markets or other investment options.

This especially holds true for employees of top companies since they get special and lower interest rates when compared to others.

Additional Reading: How To Get Your Investment Strategy Spot On

Penalty Charges

The penalty on foreclosure of loans varies from bank to bank. While some banks don’t charge a penalty on foreclosure of a loan, others may levy a charge depending on when the foreclosure happens.

For example, some banks charge a 5% penalty if the loan is pre-paid in the second year, and 3% if it’s done later than that.

Some banks also allow borrowers to make pre-payments towards their loans only twice after the first year of the loan tenure has been completed, while other banks do not allow any kind of pre-payment.

You also have banks that don’t charge any pre-payment penalty but do so in case of a foreclosure. So, even before you decide to pre-pay or foreclose your Car Loan, check the policies and charges involved with the bank that has sanctioned your loan.

Additional Reading: What To Look For In A Car Loan Agreement

Switch To Another Bank

We understand that you want to pay off your Car Loan if you have extra funds on hand. However, before you do that, why not switch to a different bank?

That’s right! You can choose to transfer your loan to another bank that offers a lower rate of interest. Although doing this would once again involve extra charges and processing fees, it is generally a good option to switch banks if the rate of interest is significantly lower and the additional charges are not too high.

Additional Reading: Everything You Need To Know About Car Loan Transfer

Loan Tenure

The loan tenure is also an important factor to consider before you decide to pre-pay or foreclose your Car Loan. You can maximise your savings only if you foreclose your loan during the initial period of its tenure. It doesn’t make much sense to foreclose your loan towards its latter stages since you would have already paid most of the interest by then.

You can use an online Car Loan EMI calculator to find out the outstanding principal amount and make an informed decision.

Additional Reading: Drama Lama’s Car Loan Dilemma

Impact On Credit Score

Foreclosing your Car Loan could also affect your Credit Score in the long run. While most of may be under the impression that prepaying a loan would help us save on our EMIs and improve our Credit Score, the reality is a little different.

You have to understand that every time you pay your EMI on time, your Credit Score is boosted by a fraction. Over the years, this is your best shot at improving your bad credit history, if you have any. However, if you decide to pay off all your debts at once, your Credit Score doesn’t really improve in the same proportion.

Additional Reading: Foreclosing A Loan? Few Things To Keep In Mind To Keep Your Credit Score Intact

After considering all these factors, you may want to think again if you’re planning on foreclosing or prepaying your Car Loan. Instead, use the surplus funds you have to pay off other debts or make investments that will see your money grow over time.