Personal loans are a convenient option for people who need money quickly for a variety of reasons. But before you start researching how to apply for a personal loan, you should first understand the terms and conditions you’ll agree to once your loan is funded. One of these terms that are often misunderstood is pre-closure.

How does pre-closure work

Preclosure is better known as “prepayment,” which is when the borrower pays off their personal loan, mortgage, or another type of loan in full before the full term has been completed. It’s important to note that pre-closure is not the same as defaulting. A borrower who defaults on their loan will have their loan seized by the lender and may be subject to penalties.

What are the benefits of pre-closure?

The benefits of preclosure are that it can save you money in the long run. By paying off your personal loan before it’s due, you’ll avoid interest and fees that would be added to the balance if you continued to make payments for the full duration.

The drawbacks of pre closing a loan

The most significant drawback of paying off your loan early is that you might incur what’s known as a “prepayment penalty.”  Prepayment penalties are charged by lenders for loans that are paid back early since they’ll lose money on the projected interest they expect to receive. Prepayment penalties may seem unfair as you’re being penalized for acting in a financially responsible way, but loans cost money to fund and service. If you pay your loan off early the bank takes a loss and needs to make up the costs of servicing your personal loan. It’s essentially seen as a compromise from both parties: they’ll accept your loan pay-off today but only if you cover the costs they already spent funding your loan.

Prepayment penalties aren’t absolute and many lenders won’t charge you a fee to pre close your loan early. There may also only be a penalty assessed if your loan is paid off within the first few months of funding; you’ll rarely see a penalty for paying your loan back a month or two early.

How to pay off your personal loan early

Step 1: Request a pre closure agreement from your lender.

This document will outline the terms of your early pay-off and should be completed before you pay off your loan. In it, you’ll agree to repay the loan early and waive any prepayment penalties that may apply.

Step 2: Make the final payment.

You’ll need to make a lump-sum payment to your lender at least ten days before you preclose your loan. This will cover the costs associated with your preclosure, such as fees and loss of interest income on your loan.

Step 3: Pre Close the loan.

Once you’ve paid off your personal loan, you can preclose it by completing a form with your lender. This will officially end the contract between you and them and make it possible for you to receive a final discharge statement from them confirming that the debt is gone.

The bottom line

Preclosure of your personal loan is a simple process that can help you pay off your debt faster. Just be sure to understand what penalties you may be responsible for before signing the contract on your loan.

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