Foreclosure of a business loan good or bad?

A business loan is a huge liability for a business which may make us consider paying off the debt in full to prevent future EMIs. While considering closing a loan earlier, we are torn between reducing the loan’s term and increasing our EMIs. When a loan is foreclosed, the entire outstanding balance is paid off in one go rather than through numerous EMI payments. As a part of the process, you can pay back a loan before the agreed-upon EMI time.

Foreclosure fees

When you foreclose on your business loan, the lender loses the income from the loan that comes from the interest. Lenders may impose prepayment penalties and foreclosure fees to stop businesses from going into foreclosure. The savings on interest charges realized in the event of a partial payment or foreclosure are collected in the form of these penalties. Make sure to carefully examine the terms and conditions if you wish to close a business loan. Before you apply for a loan, you can also bargain with the lender to get the foreclosure fee removed.

Right financial decision

You are not required to prepay a business loan even if you can. Make sure there are no other financial responsibilities you have to meet before deciding to foreclose on the loan. It may be used for making other payments or covering seasonal losses, or it may be used to buy new machinery or equipment, stock, etc.

Advantages of foreclosure:

Save on interest

Early closure can help you save money on the interest portion of your monthly payments if you’ve availed of a high interest business loan. Paying off the loan early saves money that would have been used to pay the interest.

A higher credit rating

Closing your debts earlier than the set tenure may improve your credit score. Lenders are more likely to approve your loan applications in the future if you have a better credit rating. As a result, you’ll find it easy to qualify for loans. In addition to quick approvals, a high credit score may also help you obtain attractive interest rates.

Disadvantages of foreclosure:

1. Hefty foreclosure fees

Although foreclosing might result in significant interest savings, you must also take into consideration foreclosure fees on business loans. These fees typically vary from 2% to 6% of the outstanding loan balance.
Paying the additional percentage can significantly reduce your savings when you are already using a lump sum payment. Therefore, it’s crucial to conduct your math before foreclosing. Calculate your overall interest savings, then deduct the foreclosing penalty from it. If the outcome is favorable, only then choose to foreclose.

2. Tax deduction

Section 24C of the Income Tax Act allows loan borrowers to deduct interest payments from their taxes. However, you essentially give up these advantages when you foreclose on your loan. In the worst situation, your company can find itself in a higher tax bracket than it was before.

Closing Thoughts

Pre-closing might be a smart move if you have extra cash on hand and some time until you can pay back the entire loan amount. Pre-close before your loan tenure is about to expire. You’ll be able to take advantage of some savings as a result. Remember that interest rates are highest at the beginning of a loan term, thus paying off the debt sooner rather than later will benefit you more.

It can be a good idea to find out if you will lose any tax benefits by closing before you do so. Remember to verify that the tax credit you are receiving from your mortgage loan is roughly equal to the amount of interest you will save by paying off the loan early.
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