Preclosure Benefits: Cibil Score Boost With Early Loan Closure

In India, a person's creditworthiness is measured by their CIBIL score, which is a three-digit number ranging from 300 to 900. A score above 750 is considered good and can bring advantages such as quick loan approvals and lower interest rates. A lower score, on the other hand, can make a person appear to be a risky borrower, leading to higher interest rates or even rejection of loan applications. One of the factors that can impact a person's CIBIL score is the foreclosure or pre-closure of a loan. Loan foreclosure refers to the early repayment of a loan before the original loan term ends. While it can demonstrate financial discipline, it can also negatively affect a person's CIBIL score, making it more difficult to secure new loans in the short term. However, if done responsibly, it can improve a person's score by reducing their outstanding debt. Therefore, it is important to understand the impact of foreclosure on a CIBIL score and to carefully consider the advantages and disadvantages before deciding to pre-close a loan.

Foreclosure of a loan can negatively impact CIBIL scores

Firstly, let's understand what foreclosure means in the context of loans. Foreclosure occurs when a borrower is unable to make the required payments, leading to the lender seizing the collateral used to secure the loan. This is different from loan settlement, which refers to closing a loan account by paying a minimum amount after defaulting. Loan foreclosure is a voluntary closure of the loan account by paying the remaining amount in full.

Now, let's discuss how foreclosure can affect your CIBIL score. When you foreclose a loan, your CIBIL score may take a temporary dip. This short-term negative impact on your creditworthiness can make it challenging to secure new loans immediately after pre-closing a loan. The reason for this dip is that credit scoring models are designed to predict the risk of potential borrowers defaulting on their debts. By closing a loan account, the account's payment history becomes less influential, even if you had a solid history of on-time payments. Additionally, keeping an installment loan open for its entire life could help maintain your credit score, as it provides more data points for credit scoring models to assess your creditworthiness.

Furthermore, there might be foreclosure charges depending on your lender and the tenure of the loan. These charges can be significant, ranging from a percentage of the loan's outstanding value to a set number of monthly interest payments. It is crucial to review your loan agreement carefully to understand any potential prepayment penalties.

However, it's important to note that the impact of foreclosure on your CIBIL score might vary depending on other factors. For example, if you have other active loans or credit card balances, the negative impact of foreclosure might be mitigated. Additionally, practicing good credit habits and maintaining a low debt-to-income ratio can help minimize the effect of foreclosure on your CIBIL score.

Pre-closing a loan can make it harder to secure new loans

Pre-closing a loan can have a significant negative impact on your CIBIL score, which is a crucial measure of your creditworthiness in India. A temporary dip in your CIBIL score can make it more difficult to secure new loans immediately after pre-closing a loan.

A CIBIL score is a three-digit number ranging from 300 to 900 that represents your creditworthiness based on your credit history. A good CIBIL score indicates that you have a strong credit history and are likely to be a responsible borrower. Lenders use CIBIL scores to assess the risk of lending to an individual and determine their eligibility for a loan.

When you pre-close a loan, your CIBIL score may take a hit for a short duration. This temporary dip can affect your creditworthiness and make it harder to secure new loans immediately after pre-closing. Lenders may view a recent loan pre-closure as a sign of financial instability or increased risk, which could lead them to deny your loan application or offer less favourable terms.

Additionally, pre-closing a loan can impact your debt-to-income (DTI) ratio, which is another critical factor considered by lenders during the loan approval process. Your DTI ratio compares your total monthly debt payments to your monthly income. When you pre-close a loan, your monthly debt payments may decrease, but your overall debt obligations remain the same. As a result, your DTI ratio may increase, potentially making it more difficult to secure new loans or qualify for favourable terms.

It is important to note that the impact of pre-closing a loan on your ability to secure new loans depends on various factors, including your credit history, income, and overall financial situation. While pre-closing a loan can have negative consequences, it is not always detrimental. In some cases, pre-closing a loan may improve your CIBIL score by reducing your outstanding debt.

Foreclosure charges can be high, depending on the lender

Foreclosure charges can vary significantly depending on the lender and the type of loan. Some lenders may not charge any foreclosure or prepayment penalties, especially for floating-rate term loans. In contrast, others may impose a fixed penalty based on the interest rate for a predetermined number of months.

It is important to carefully review the loan documents and understand the methodology used by the lender to determine the prepayment charges. Some lenders may use the interest differential method, which is based on the balance principal amount and the difference between the original and existing interest rates. The prepayment fees charged by banks can vary considerably, typically ranging from 4% to 5% of the outstanding loan amount.

It is worth noting that banks may discourage prepayment because it results in a loss of potential income for them. They incur additional charges when rerouting the cash through the credit channel for early loan repayment. As a result, some banks may charge a foreclosing fee or a prepayment penalty, also known as foreclosure charges, to cover the lost interest revenue from the early closing of the loan.

To make an informed decision, it is advisable to calculate the prepayment penalty charges and assess your financial condition before opting for prepayment. Additionally, consider using a prepayment calculator to monetize the advantages of low prepayment charges and assess the probability of prepaying the loan amount based on your financial standing.

Loan settlement affects CIBIL scores more negatively than foreclosure

In India, a CIBIL score is a crucial measure of an individual's creditworthiness. It is a three-digit number ranging from 300 to 900, which is based on their credit history. Banks and lenders in India refer to an individual's CIBIL score to assess their creditworthiness before approving any loan or credit card applications.

Loan foreclosure, also known as pre-closure, is when a borrower voluntarily closes their loan account by paying off the remaining amount in full before the end of the tenure. While loan foreclosure can negatively impact an individual's CIBIL score, the effect is not as detrimental as loan settlement. When a borrower forecloses a loan, their CIBIL score may take a temporary dip, which can affect their creditworthiness in the short term. Additionally, they may have to pay high foreclosure charges, depending on the lender and loan tenure. However, if done responsibly, foreclosure can improve an individual's CIBIL score by reducing their outstanding debt.

Loan settlement, on the other hand, occurs when a borrower is unable to repay their loan due to financial hardship and requests temporary relief from the lender. The lender may then offer a one-time settlement, allowing the borrower to make a lump-sum payment after a period of non-repayment. Loan settlement is marked as 'settled' on the borrower's credit report, which is a negative indicator of credit behaviour. This results in a more significant drop in their CIBIL score, and the record remains for seven years. During this period, borrowers may face challenges in securing new loans as lenders may doubt their repayment capability or reject their applications.

To summarise, while both loan foreclosure and loan settlement can negatively impact an individual's CIBIL score, loan settlement has a more detrimental and long-lasting effect. Borrowers should explore alternative options such as restructuring their loan, extending the repayment tenure, or using savings before opting for loan settlement.

CIBIL scores above 750 are considered good in India

A CIBIL score is a three-digit number ranging from 300 to 900 that represents an individual's creditworthiness based on their credit history. It is a crucial measure of an individual's creditworthiness in India and is the most commonly used credit rating in the country. A higher CIBIL score indicates higher creditworthiness, making it easier to secure loans and credit cards with favourable terms.

CIBIL scores above 750 are considered excellent in India and offer significant benefits. About 43% of Indians from metro cities have a credit score of 750 or above. This score signifies a strong credit history and makes it easier to secure loans and credit cards with favourable terms. With a score above 750, an individual is likely to get approved for a loan at the best interest rate. Lenders view borrowers with a score above 750 as reliable, making them more comfortable offering loans.

While there is no one path to achieving an exceptional credit score, certain crucial variables can help build and maintain a good CIBIL score. These include consistently paying all credit card dues and loans on time, maintaining a low credit utilisation ratio, and having a healthy mix of credit types (such as loans and credit cards) managed responsibly. Additionally, it is important to strive for a low credit utilisation rate, generally around 30%, as it improves credit utilisation.

It is worth noting that foreclosure or pre-closure of a loan can impact an individual's CIBIL score. While loan settlement (closing a loan account by paying a minimum amount after defaulting) negatively affects the CIBIL score, voluntary loan foreclosure (closing a loan account by paying the remaining amount in full) may have a less negative or positive impact. Responsible pre-closure of loans can improve the CIBIL score by reducing outstanding debt. However, it is important to understand the effects of pre-closing loans and make informed decisions to navigate the financial journey effectively and improve credit health in the long run.

Frequently asked questions