Prepayment penalties on two-wheeler loans can significantly impact your overall borrowing cost. If you're considering prepaying your loan, it's crucial to understand the associated charges and how they can affect your financial plan. In this blog, we will understand what two-wheeler loan prepayment charges are, their impact, and how you can reduce or avoid them when foreclosing your loan ahead of schedule.
What Happens When You Repay Your Loan Early?
When you take a bike loan, you sign up for a fixed tenure, usually for 2-3 years*, with equated monthly instalments (EMIs). The EMI consists of principal and interest components. By repaying early, you forego paying the remaining EMIs. This saves on interest costs but may result in prepayment penalties.
Some of the banks and NBFCs (Non-Banking Financial Companies) charge this fee to compensate for the loss of interest income when you close the loan prematurely. The prepayment penalty on a two-wheeler loan varies from 0-4%* of the outstanding principal. Some banks and NBFCs also levy processing fees for early closure. So, you need to factor in these additional two-wheeler loan prepayment charges before deciding to foreclose the loan.
Bike Loan Prepayment Penalty: An Overview
A prepayment penalty on two-wheeler loan, also called foreclosure or pre-closure charge, is a fee levied when you repay your loan ahead of the tenure, either fully or partially. The loan agreement outlines the prepayment structure with applicable charges for two-wheeler loans.
Prepayment penalties are usually a percentage of the outstanding principal amount. For instance, if your outstanding balance is ₹1 lakh and the loan provider charges a 2% prepayment fee, you will pay ₹2,000 as a penalty when foreclosing the loan.
Why Do Financial Institutions Charge a Prepayment Penalty on a Two-Wheeler Loan?
There are a couple of reasons why banks, NBFCs, and other institutions charge prepayment penalty on two-wheeler loan:
- Lost Interest Income: When you foreclose a loan, the financial institution loses out on the interest income from your future EMIs. The penalty helps cover a portion of this lost revenue.
- Administrative Costs: Processing early loan closure involves administrative work for the bank, including handling paperwork, documents, accounting, etc. The penalty helps recover these overhead costs.
Without such bike loan prepayment charges, borrowers may randomly foreclose and re-apply for loans to take advantage of rate changes. This would increase operational costs for financial institutions.
Impact of Prepayment Penalties on Two-Wheeler Loans
Prepayment penalties can have a significant impact on your two-wheeler loan costs. Here are some key aspects to consider:
1. Increased Interest Costs
Prepayment penalties increase your total interest outgo over the loan tenure. When you make lump sum payments to foreclose the loan, you save on future interest costs. However, the penalty charge eats into your savings. The higher the penalty, the lower your overall interest savings.
2. Cash Flow Impact
A bike loan prepayment penalty is an unanticipated cash outflow. If the foreclosure charge is disproportionately high, it can strain your finances. You need adequate funds upfront to cover the principal outstanding, interest dues, and penalty charges.
3. Loan Tenure Impact
Prepayment penalties also influence your decision on the ideal loan tenure. Shorter tenures have higher EMI costs but lower total interest outgo. If you foresee making prepayments, shorter tenures are better since the penalty applies to the lower principal outstanding.
4. Opportunity Cost
The prepayment amount could have been invested elsewhere to earn returns. Instead, you incur a penalty cost without any return on your money. Depending on other investment avenues, this can result in significant opportunity costs.
Full Prepayment and Its Effect on Your Credit Score
You can choose to foreclose the entire loan amount before the tenure is completed. This is known as full prepayment or complete pre-closure. Closing your two-wheeler loan has the following impact on your credit score:
Advantages:
- Timely loan repayment and early closure reflect positively as good repayment behaviour.
Disadvantages:
- Loan foreclosure reduces your credit mix since you have one less active loan.
- Full prepayment results in loan closure on credit records rather than completion after having paid all EMIs.
Overall, full prepayment has a minor impact if you have a long credit history and a healthy score. However, do check your score a few months after closure to ensure no major fluctuations.
How To Minimise Two-Wheeler Loan Prepayment Penalties
Here are some tips to reduce or avoid prepayment penalties on your two-wheeler loan:
Compare Loan Offers
Compare multiple banks and NBFCs to find bike loans with lower or no prepayment penalties. Opt lenders that provide competitive offers with lower foreclosure charges.
Opt For Shorter Tenures
As discussed earlier, shorter loan tenures attract lower prepayment penalties since the principal outstanding is lower.
Time Your Prepayment
Review your loan agreement to identify specific lock-in periods for prepayments. Some loan providers may not charge a penalty if you foreclose after 12-24 months*. Timing your prepayment to coincide with such intervals can eliminate penalties.
Pay From Own Funds
Some financial institutions levy higher prepayment penalties if you foreclose through refinancing from another lender. Using one's own funds can help reduce foreclosure charges in such cases.
Prepay Annually
Instead of one lump sum payment, consider making incremental prepayments yearly. Some financial institutions allow annual prepayments up to a limit without charging a penalty.
Pay EMI In Advance
Paying future EMIs in advance reduces your outstanding principal. Based on the loan terms, this may not attract a prepayment penalty.
Shop Around for the Best Deals
Not all banks and NBFCs charge the same prepayment penalties. Before taking a loan, compare multiple institutions on parameters like:
- Rate of interest
- Processing fees
- Prepayment structure and charges
- Part payment facility
This will help you identify bike loans with minimal or no prepayment penalties. Moreover, if your chosen financial institution charging high foreclosure charges, try to negotiate for a lower rate at the time of loan disbursal.
The Bottom Line
Prepayment penalties can erode the savings from foreclosing your two-wheeler loan prematurely. While it may not be possible to eliminate the prepayment penalty on two-wheeler loan entirely, prudent planning can help minimise the impact. Nevertheless, evaluate your finances, loan offer terms, and interest rate outlook before deciding to foreclose the loan. With some diligence, you can avoid paying unreasonably high prepayment penalties on your bike loan.
FAQs
1. Is prepayment penalty legal in India?
Yes, prepayment penalties are legal in India. The terms and charges are outlined in the loan agreement per RBI guidelines. Financial institutions have the right to levy pre-closure or foreclosure charges as per the agreed mutual contract.
2. How many times can prepayments be done?
Most financial institutions allow part prepayments up to a specified limit per year, usually 10-25%* of the outstanding principal. Beyond this, you can make any number of prepayments but may incur penalties. There is normally no restriction on the number of times you can prepay small amounts within the limit.
3. Does prepayment reduce interest?
Yes, any prepayment towards your loan principal helps reduce your overall interest outgo. Subsequent EMIs are calculated on the outstanding principal after the prepayment. The interest savings depend on the prepayment amount and remaining tenure.
4. Are foreclosure charges applicable on transfer of two-wheeler loan?
Most financial institutions allow loan transfers or takeovers without levying pre-closure charges. So, you can transfer your bike loan to another lender that offers better rates without paying foreclosure penalties. However, it is important to check with your loan provider for their terms and conditions.
