What are Foreclosure Charges on Business Loan

Most Indian proprietors seek business loans either for enlargement or upkeep, and such loans usually come with flexible repayment options. Nevertheless, some borrowers may like to settle their debts earlier than was initially planned in order to reduce interest charges. This process is called "foreclosure." It might seem cost-effective, but it attracts closure costs, commonly called foreclosure charges.

Whenever borrowers decide to close their loan term earlier than was initially agreed upon, lenders charge them fees known as foreclosure charges. When looking for any form of a business loan, such as a loan against property or low-interest small business loans it is important for one to understand these charges because they can have great implications on overall savings balance and debt servicing capability.

What Are Foreclosure Charges?

In essence, these are fees imposed by lending institutions when customers decide to pay back the entire borrowed amount before the end of the prescribed period. If, for example, you borrowed for 5 years but decided to clear your debt within three years, then you may incur foreclosure charges to the lender, which range widely between 2% to 5% of the outstanding loan amount based on different lenders and types of loans.

Also read: Everything You Need to Know About Loan Foreclosure

Why Do Lenders Impose Foreclosure Charges?

Lenders generate revenue from the interest accrued over the period that the borrower is supposed to repay the loan. As such, when the borrower pays the loan before its time, chances are that the lender might not get this interest, hence leading to the imposition of foreclosure charges. The following reasons will provide a basic explanation:

• Loss of Interest: Lenders project their profits on what they expect from the interest within the loan tenure.
• Cost of Administration: The process involves several administration steps that cost money.

With regard to non-banking financial institutions (NBFCs) as well as banks in India, foreclosure charges are generally regulated by Reserve Bank of India (RBI) rules. However, these charges vary with different financial service providers as well as the types of loans taken; this is why entrepreneurs should know how much they owe when they plan on prepaying their loans.

Loan Against Property Foreclosure Charges

For entrepreneurs who go for loans against properties, foreclosure charges could be pretty heavy. In fact, many Indian NBFCs and banks levy foreclosure charges of 2 to 4% of the outstanding principal amount. Here are some insights:

• Public Sector Banks: As regards individual borrowers, public sector banks, in general, do not impose loans against property foreclosure charges; however, some specific provisions may exist for corporate clients.
• Private sector banks and NBFCs: These might have foreclosure charges on a fixed rate for loans that are closed before a certain duration (for example, within the first year of taking the loan).

It is recommended that you inquire about your financial institution’s foreclosure rules if you are thinking of making an early payment on a loan since they may affect the extent of money saved. In addition, you can always use an online eligibility calculator to determine if you qualify for another loan. Using these online calculators can be efficient in reducing your overall efforts when applying for a loan and streamlining your calculations.

For instance, if you owe ₹10 lakh on a loan against property and your lender charges a 3% foreclosure fee, you’d be required to pay ₹30,000 as part of your early repayment.

Also read: What is Loan Against Property? - Features, Eligibility, Documents, and more.

How Foreclosure Saves You Money Despite the Charges

Foreclosure can still save money in most cases, especially for loans with high interest rates over a long duration. This is how it happens:

• Lower Interest rates: When you foreclose, it means that you do not pay interest in the future; this could accumulate to a significant amount if the tenure is long enough
• It boosts credit score: Clearing a loan earlier than expected will positively affect your credit rating, making it easier for you to borrow money.
• More cash at hand: By foreclosing, one reduces his monthly financial responsibilities, freeing money for investments or any business needs.

For small business loan borrowers getting low-interest deals, it might be worthwhile to foreclose on your current expensive loan quickly and opt for something more pocket-friendly instead. Consistent with prevailing interest rates on small business loans between 10% and 16% in India, you can strategize by opting for low-interest small business loans so that this would assist in cutting down the entire debt burden.

Also read: 10 Powerful Tips to Grow Your Small Business in India (2024)

Conclusion

Understanding foreclosure charges on business loans is vital for effective debt management. While these fees can add to your costs, foreclosing a loan early can often save money by reducing overall interest expenses. Before deciding, weigh the foreclosure charges against potential interest savings, and consider switching to low-interest small business loans if they align with your financial goals.

Apply Now to explore tailored loan options that best suit your business needs!

Key Points to Remember

Here are some of the important points about foreclosure charges:

• Charges Range: Foreclosure charges usually range from 2-5% of the outstanding balance.
• Types of Loans Impacted: Fixed-rate Loans and loans against property are often subjected to foreclosure charges, especially from private lenders or NBFCs.
• Guidelines From RBI: There are some RBI rules that limit the foreclosure charges for individuals on floating rate loans but do not apply across the board to business loans.

A Practical Example

Suppose you’ve taken a loan of ₹15 lakh for your business with a 5-year tenure at a 12% interest rate. If you decide to foreclose in the third year, your lender may charge a 3% fee on the remaining balance. However, if you calculate the savings on interest, you may still find that early closure benefits you significantly, especially if you can secure lower-cost financing elsewhere.

FAQs

Q.1. Is it mandatory to pay foreclosure charges?

A. Borrowers are typically required to pay foreclosure charges as per the terms of their loan agreement.

Q.2. Do MSMEs have to pay foreclosure charges?

A. MSMEs will be allowed to prepay loans without paying foreclosure penalties, according to RBI.

Q.3. What is the interest rate for foreclosure?

A. 4.5% on the principal outstanding at the time of foreclosure. 2.50% on the future principal outstanding on the existing loan.

Q.4. How can I avoid foreclosure charges?

A. A person can avoid foreclosure charges by making timely payments. If you have any queries about the costs related to foreclosure loans, you should contact your lender.

Disclaimer:

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