Personal Loan: Settlement vs Prepayment

Kokila Chokkanathan
Both settlement and prepayment involve paying off a personal loan early, but they differ in how much you pay, when, and the bank’s terms. Understanding the difference can save you money on interest.

1. Prepayment

Definition:
Prepayment means paying off part or full remaining loan balance before the scheduled tenure ends according to the original EMI schedule.

Key Features:

  • Can be full or partial:
    • Partial prepayment reduces the loan principal, lowering future EMIs or loan tenure.
    • Full prepayment closes the loan completely.
  • Interest is calculated only up to the date of prepayment.
  • Banks may charge a prepayment/foreclosure fee, though it is lower for floating‑rate loans.
  • Helps save interest over the loan tenure.
Example:
If you have a ₹5 lakh loan with 5 years tenure, paying ₹2 lakh after 1 year reduces principal, lowering future EMIs and interest.

Best for: Borrowers with extra funds who want to reduce interest costs without waiting for full tenure.

2. Settlement

Definition:
Settlement refers to negotiating with the lender to pay a lump sum less than the total outstanding loan amount to close the loan. This is typically done when the borrower cannot pay EMIs on schedule.

Key Features:

  • Usually occurs when the loan is stressed or in default.
  • The bank agrees to accept a lower amount than the remaining principal plus interest.
  • Settlement may hurt your credit score, as it indicates the loan was not fully repaid as per schedule.
  • Usually used as a last resort to avoid legal action.
Example:
If you owe ₹4 lakh but are unable to continue EMIs, the bank may agree to settle the loan for ₹3 lakh.

Best for: Borrowers struggling to pay EMIs and looking to close the account before default worsens.

3. Key Differences

Feature

Prepayment

Settlement

Purpose

Reduce interest or close loan early

Avoid default when unable to pay full loan

Payment Amount

Full remaining principal (or partial prepayment) + accrued interest

Negotiated lump sum (usually less than total due)

Impact on Credit Score

Positive or neutral

Negative (marks as “settled/partial payment”)

Bank Approval

Usually allowed as per loan agreement

Requires negotiation with lender

Fee

Possible prepayment/foreclosure charges

Often waived or adjusted in settlement negotiation

Timing

Any time during loan tenure

Usually after defaults or difficulty in paying EMIs

4. When to Choose Prepayment vs Settlement

Prepayment:

  • You have extra funds or a windfall.
  • Want to save interest and reduce loan tenure.
  • Loan is performing and EMIs are being paid on time.
Settlement:

  • You are struggling to pay EMIs due to financial difficulties.
  • Want to avoid default or legal action.
  • Accept that your credit rating may be impacted.
5. Key Takeaways

  • Prepayment = proactive, planned early repayment, beneficial for your finances and credit.
  • Settlement = reactive, negotiated repayment due to difficulty, may impact credit history.
  • Always check your loan agreement for prepayment charges and settlement policies before making any decision.
 

Disclaimer:

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any agency, organization, employer, or company. All information provided is for general informational purposes only. While every effort has been made to ensure accuracy, we make no representations or warranties of any kind, express or implied, about the completeness, reliability, or suitability of the information contained herein. Readers are advised to verify facts and seek professional advice where necessary. Any reliance placed on such information is strictly at the reader’s own risk.

For more interesting updates click and follow Indiaherald WhatsApp channel

Find Out More:

Loan

Related Articles: