Loans play a crucial role in helping both individuals and businesses meet their financial requirements and achieve their goals. Whether it is buying a home, financing education, or expanding a business, loans provide the funds necessary to make your dream a reality.
However, with borrowing comes the responsibility of repayment of the loan. If you plan to borrow funds in the near future, understanding the meaning of loan repayment is essential. In this article, we will be delving into the concept of loan repayments, including the various types of loan repayment methods that are commonly available.
Loan Repayment Meaning
Loan repayment refers to the process by which you return the money borrowed from a lending institution. The repayment of a loan is often done with interest according to the terms and conditions agreed upon when borrowing.
A typical loan repayment process often involves making regular repayments over a specified period (known as the loan term) until the borrowed amount, along with interest and other charges, is fully paid off.
Each loan repayment that you make typically consists of two components: principal and interest. The principal refers to the original amount that you borrowed from a lender. The interest, meanwhile, is the charge that you pay for borrowing money. The interest is often calculated as a percentage of the principal.
What are the Different Types of Loan Repayment Methods?
Depending on the type of loan and its terms, there can be different types of loan repayment methods. Some of the more common types include the following:
1. Fixed Repayments
In a fixed-repayment loan, you are obligated to pay the same amount each month throughout the entire loan term. Also known as the Equated Monthly Installment method, this particular type of loan repayment is predictable and makes it easier to budget expenses.
2. Variable Repayments
In these types of loan repayment methods, the monthly payments may change over time, often in response to fluctuations in interest rates. Although this method may reduce payments during low-interest rate environments, it can make long-term financial planning challenging.
3. Deferred Repayments
In deferred repayments, the loan EMIs only start after a set period expires. These types of loan repayment methods are often used for student loans.
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4. Increasing Repayments
With increasing repayment loans, the loan obligations often start low and gradually increase over time to align with expected income growth.
5. Balloon or Bullet Repayments
In these types of loan repayment methods, you only pay the interest component of the loan throughout the tenure. The principal loan amount must be repaid as a single lump sum payment at the end of the term.
Why is Timely Loan Repayment Important?
Repayment of a loan on time can have a huge positive impact on your financial health as a borrower. Here are some of the reasons why you should repay your loan on time.
1. Credit Score Impact
When you make consistent and on-time payments, you can increase your credit score. Meanwhile, late or missed payments can significantly damage it. A good credit score is essential for future borrowing opportunities and securing favourable loan terms.
2. Financial Health
Timely repayments help maintain financial stability by preventing the accumulation of additional fees and penalties that are often associated with late payments.
3. Better Borrowing Capacity
A strong repayment history enhances your credibility and can potentially lead to better terms on future loans.
4. Financial Discipline
Regular repayments help cultivate good financial habits and discipline, both of which are beneficial for long-term financial management.
5. No Legal Consequences
Failure to make repayments of loans can result in severe legal actions. These include lawsuits or repossession of pledged property in the case of secured loans.
Things to Consider About Loan Repayments
Now that you are aware of what repayment of a loan is, here is a quick overview of some of the key things you must consider when managing loan repayments.
1. Interest Rates
The interest rates are one of the most important factors that impact the repayment of a loan. The higher the interest rate, the higher the loan EMI is likely to be. Additionally, fixed and variable interest rates can also impact the way you manage your loan and financial health.
2. Loan Tenure
The length of the loan tenure also affects the size of monthly payments and the total interest paid over the life of the loan. A longer tenure often leads to lower monthly payments but significantly increases the total interest paid over the tenure.
3. Early Repayment Options
Most loans provide the option to make early repayments or partial payments with or without a penalty. If you have idle funds, you can significantly reduce your interest burden by making early repayments.
4. Automatic Payments
Setting up an automatic electronic mode of repayment can help avoid missed EMIs. As the set date approaches, the loan repayment is made automatically from the designated bank account, ensuring that you maintain a consistent track record of paying your loan obligations.
5. Refinancing Opportunities
The interest rate environment is ever-changing. Therefore, keep an eye on market conditions and personal financial improvements. A positive change can allow for favourable loan refinancing.
Conclusion
With this, you must now be aware of what loan repayment is and its various types. Now, although there are various types of loan repayment methods available, the most common is the fixed repayment method, also known as the Equated Monthly Installment method. From personal loans and home loans to education loans and business loans, lenders usually only offer the fixed repayment method.
That being said, merely understanding the meaning of loan repayments is not enough. As a borrower, it is crucial to recognise the importance of timely payments. This way, you can ensure that you make informed decisions and effectively maintain financial health.
FAQs
What happens if I miss a loan payment?
If you miss a loan payment, the lender will charge a late fee and report the non-payment of EMI to the credit bureaus, which can significantly impact your credit score.
What is loan amortisation?
Loan amortisation is the process of spreading out a loan into a series of monthly fixed payments over a certain period of time. Each monthly fixed payment consists of both principal and interest components.
Is it possible to change my loan terms?
If you have already accepted the loan terms and have started the repayment of the loan, you may not be able to change your loan terms. However, some banks and financial institutions are flexible and allow you to negotiate your terms after a certain period. Alternatively, refinancing a loan could also be a good way to alter the loan terms.
How can I lower my monthly loan repayments?
There are multiple ways to lower your monthly loan EMIs. Some options include extending the loan term, making a partial lump sum payment, or refinancing at a lower interest rate.
Are there any tax benefits to loan repayments?
Home loan repayments are eligible for multiple tax benefits under the Income Tax Act of 1961. The principal component of home loan repayments you make during a year can be claimed as a deduction under section 80C to the tune of ₹1.5 lakh per financial year. Meanwhile, the interest component of home loan repayments you make during a year can be claimed as a deduction under section 24(b) to the tune of ₹2 lakh per financial year.
