Impact of loan foreclosure on credit score

Understand the relationship between loan foreclosure and your credit score, and how the Bajaj Finserv Credit Pass can help you stay creditworthy.

In the world of finance, the term ‘loan foreclosure’ might sound like a superhero move to vanquish debt. But, before you rush in, it’s well worth the time to consider a loan foreclosure’s significant repercussions on your credit score.

Understanding loan foreclosure

At its core, foreclosure is a process by which a borrower repays the entire outstanding loan amount in a single lump sum payment before the end of the loan tenure. In India, loan foreclosures are an option provided by most lenders. Borrowers may pre-close their loans after they’ve paid a certain number of EMIs or Equated Monthly Instalments. However, it’s important to consider that such a move comes with certain conditions, including a prepayment penalty charge, ranging anywhere between 1% to 5% or more, depending on the outstanding balance before the foreclosure.

Your credit score

Your financial behaviour is reported by lenders to credit information companies like TransUnion CIBIL. Based on this information that they collect from various financial institutions, credit bureaus generate your credit report and calculate your credit score. In calculating your credit score, credit bureaus weigh a set of key factors to determine your reliability as a borrower. These include your repayment history, your credit utilisation ratio, your credit age, credit enquiries, and credit mix.

The higher your credit score, the more creditworthy you appear to lenders. A good CIBIL Score is generally considered to be upwards of 750 on a scale of 300 to 900. Such a score brings a host of advantages such as quick approvals, lower interest rates, and favourable terms, including longer tenures. On the other hand, a lower

credit score paints you as a risky borrower, meaning your application might not get approved, and even if it does, you might end up with higher interest rates.

The impact of a foreclosure

So, how does a foreclosure fit into this picture? Well, though it might surprise you, foreclosing a loan can negatively impact your credit score; and we’re not talking about a minor dent, we’re talking double digits.

Let’s understand why. When sanctioning a loan, lending institutions create a repayment schedule for your EMIs after taking into account its protocols for asset liabilities management so as to generate interest for an optimal period. When you foreclose your loan, you disrupt these calculations. Banks are compelled to let go of a considerable amount from their end, for which they will expect compensation. As a result, they charge a prepayment penalty fee for loan foreclosure.

All the details about your foreclosure get recorded in your credit report and reflected in your credit score, meaning it’s available to all potential lenders down the line. Foreclosing a loan might lead to a double digit decrease in your credit score, potentially plummeting your score well below what’s considered good.

What does this mean for you? Well, it might make your financial life a bit more challenging. Lenders might hesitate to extend credit to you because of your low credit score. Even if they do approve your credit application, they might saddle you with strict terms that require you to offer collateral or a co-signer.

Making an informed decision

Given the potential consequences, it’s advisable to do a cost-benefit analysis before foreclosing any loan. Your future credit requirements could be significantly affected by the negative impact of a loan foreclosure on your credit score, limiting your eligibility for credit products.

On the other hand, if you’re certain that you won’t require credit anytime soon and the extra foreclosure charges won’t cause financial strain, then a loan foreclosure could be helpful in freeing you from debt earlier than planned.

How Bajaj Finserv Credit Pass can help

Managing your credit profile and building a robust credit score doesn’t have to be a daunting experience. Powered by India’s oldest credit information company, TransUnion CIBIL, Bajaj Finserv provides a unique Credit Pass membership, the go-to for all your credit monitoring and management needs. Make the most of its many advantages to keep your credit health in good shape, especially if you’re toying with the idea of foreclosing a loan:

● Regular credit score checks: The Credit Pass allows you to check your CIBIL Score every month. Regularly monitoring your credit score can help you understand your credit health and take necessary actions to maintain or improve it.

● Personalised dashboard: Access a summary of all your loan and credit card accounts in one place. This can help you keep track of all your debts and manage them effectively so you can estimate your preparedness for a foreclosure.

● Credit factors tracking: Whether it's your repayment history or your credit utilisation, you can track the factors that impact your credit health with the Credit Pass. Understanding and analysing these factors can help you make informed decisions about loan repayments, including foreclosures.

● Interactive tools: The Credit Score Simulator can help you predict the possible impact of various financial decisions on your credit score, guiding you in making decisions that won’t negatively affect it. The EMI Calculator can help you assess what a financial decision might add to your monthly financial obligations, even before you apply.

What’s more, these benefits are available for free for the first 12 months when you sign up during the limited-period offer.

While a loan foreclosure might provide immediate debt relief, it isn’t a choice to be taken lightly, especially when it comes to your credit score. Careful consideration of your current financial situation and future credit needs will help you make a decision that holds you in good standing. The Bajaj Finserv Credit Pass can be a valuable ally in that endeavour by providing you with the valuable insights you need to make smarter decisions and maintain a healthy CIBIL Score. Sign up today to ensure your financial stability and safeguard your future credit opportunities.