Prepaying a Loan Before Retirement

We all face the dilemma of repaying loans or investing and saving for retirement. Salaried individuals usually rely on loans to meet their goals of housing and other discretionary aspirations. 
Jan 2023
3 mins read

Individuals will enhance their earning capability over time, making them believe that their obligations would be paid off sooner. The cause for this concern is the excess cash or surplus that accumulated as a result of the rise in income.

Decide between paying off loans vs savings
When making a decision, consider your entire financial situation. This can include whether you have someone else on whom you can rely if you are unable to handle unexpected bills. If you are undecided about which approach is best for you, sharing your disposable income between the two may allow you to reap the benefits of both.

Prepaying the loan will help lower the total interest you pay
If you make a full prepayment early in the loan's term, you save significantly on interest. A personal loan typically has a one-year lock-in period after which the entire due amount can be prepaid. Example of this would be in case you take a loan of Rs. 3 lakh for a term of 5 years @ 15% ,you will have to pay an extra interest of Rs. 1,28,219. A breakup will show that first year you end up paying Rs. 42,086 or about 33% of your total interest, the second year you pay Rs. 35,084 or 27% of your total interest amount, while you pay Rs. 26,956 for your third year or 21%, Rs. 17,522 or 14% in the fourth year and Rs. 6571 or only 5% in the final year.

Diversifying retirement savings
Prepaying a loan can help you invest your collected wealth in debt, minor savings plans, and equities. To begin, you might set aside Rs. 8-10 lakhs as a contingency fund in any savings account or fixed deposit. You should retain this as an emergency fund and only utilise it in the event of a true emergency. The remaining money can be invested in debt, low duration debt, medium duration debt, and equities. This concept of saving in buckets will assist you in keeping your money intact and not exhausting all buckets of savings at once. The goal of these retirement savings is to offset the expense of inflation while still leaving you with some money to spend each month. Liquid Funds and Short-Term Debt Funds can meet any emergency needs.

Allows for reducing of credit utilization
The credit utilisation ratio is one of the elements that influence your credit score. It is the ratio of your total outstanding credit limit on loans. Your credit utilisation rate will be zero if you have no outstanding balances on any of your loans. The more your outstanding balance, the higher your credit usage ratio. Prepayment in advance raises your credit score. When a large outstanding balance is paid off, it opens up significant restrictions on your credit and reduces it.

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