How Pre-Closure of Personal Loan Can Impact Your Credit Score

Pre-closure of a personal loan refers to paying off the entire outstanding amount before the end of the agreed loan tenure. While it may seem financially smart to close a loan early and save on overall interest costs, it’s important to understand how such a decision can affect your credit profile.

In this article, we'll explore the benefits and drawbacks of early closure of personal loans and their actual effect on your credit score.

Related Read: What Is Personal Loan Prepayment and How Does It Work?

Pros and Cons of Personal Loan Pre-Closure

Prepaying a personal loan can be a strategic financial move, especially when you have surplus funds. However, there are both advantages and disadvantages to consider before making the decision:

Benefits of pre-closing a personal loan:

• Saves on Interest Costs: Early repayment reduces the total interest paid over the loan tenure – particularly if the loan is closed in the early years, when interest makes up a large portion of the EMI.
• Improves Debt-to-Income Ratio: Paying off a loan frees up a portion of your monthly income, improving your financial flexibility and capacity to take on other responsibilities.
• Boosts Future Loan Eligibility: Reducing current liabilities can enhance your chances of getting approved for higher-value loans in the future.

Potential downsides:

• Pre-closure Charges: Many lenders impose personal loan pre-closure charges, which can partially offset the benefits of saving on interest.
• Reduced Credit History Length: Closing a loan early may shorten your credit history, especially if it was your only ongoing loan account.
• Lost Opportunity to Build Repayment Track Record: A longer and consistent repayment history helps build a strong credit profile over time. Early closure means fewer reported months of on-time payments.

You can use a personal loan EMI calculator to estimate potential interest savings and compare them against any applicable prepayment penalties. It’s also advisable to check with your lender regarding the terms and conditions before proceeding.

Impact of Early Closure of Personal Loans on the Credit Score

Credit scores are calculated based on multiple factors, including payment history, credit utilisation, credit mix, and the length of credit history. Here's how the early closure of personal loans may affect your score:

• Marginal Positive Effect: If personal loan accounts are closed after consistent, on-time payments, it may give your score a slight positive nudge by reducing your credit exposure.
• Shortened Credit History: Personal loans contribute to your credit age. Closing them early can reduce the average age of accounts, which may slightly lower the score.
• Effect on Credit Mix: A healthy mix of secured and unsecured credit improves creditworthiness. Early closure of personal loans may shift the balance, especially if your remaining credit is mostly revolving (such as credit cards).
• Impact on Repayment Record: A longer repayment record can help your credit score. Early closure reduces the number of reported on-time payments, potentially affecting the overall payment history metric.

Overall, the impact of pre-closing a personal loan on one's credit score is usually minor and temporary. The score may fluctuate slightly, but managing other open credit responsibly plays a bigger role in maintaining a healthy score.

Conclusion

Prepaying a personal loan can be a financially sound decision if you have surplus funds and want to save on long-term interest costs. However, it’s important to weigh the expected benefits against any prepayment penalties and to understand its impact on your credit score. Always align such decisions with your broader financial goals and existing obligations.

If you’re exploring personal loan options, SMFG India Credit offers funds of up to INR 10 Lakhs* at competitive interest rates starting from only 12%* per annum. Use our personal loan eligibility calculator to estimate how much you may qualify for and apply online today!