What Is Loan Repayment, Why It Is Important, & How Does It Work?

The loan refers to the money which you or any organisation can borrow from various financial institutions like banks to manage finances. When you opt for a loan, you are liable to pay it back in a stipulated period along with the interest charged on the principal amount.

Loans can be of various types such as unsecured, commercial, secured, and personal loans. The type of loan which is best suited for you depends on your requirements and circumstances. After acquiring the loan it is equally important to repay it on time. It can be done in several forms like monthly or a lump sum payment.

When you make timely payments on your loan it helps in building a positive credit history and good credit score. This will make it easier for you to qualify for another loan in the future.

What is Loan Repayment?

Repayment of a loan means paying back the amount taken from the lender. This paying-back process is done usually via monthly payments over the stipulated period of your loan. It includes paying back the principal amount (the original sum of money borrowed) and the interest charged on it. You also have the option to pay your loan before the completion of its tenure as a lump-sum amount. However, you should consult your lender before making an advance payment of your loan as you may have to pay an early repayment fee often termed a prepayment penalty.

If you fail to pay your monthly payments on time it can affect your credit score and financial position and can even incur bad debt on you. If you think you cannot make the payments on time then you should consult your lender and financial advisor so that you can renegotiate.

Importance of Repayment of Loan

Paying back the loan should be your priority as non-payment can affect your credit score and loan liability negatively. Your loan repayment history is visible to banks and financial institutions as to whether you have paid your loan on time or not.

If you are not paying back on time you can face penalties and additional levies, and you can be termed a defaulter. This will affect your future chances of acquiring a loan negatively and there could be a risk of getting a loan at higher interest rates. Hence, it is very crucial to pay back on time as it will increase your chances of acquiring a loan at low interest with attractive offers.

How Loan Repayment Works?

Paying by Equated Monthly Instalments (EMIs) is the most common way of loan repayment. Under this arrangement, the amount of the loan is paid via fixed instalments on a particular date of every month till the tenure of the loan. These monthly instalments include the amount of principal and interest.

It is important to note that in the initial years of your loan repayment, the monthly instalments consist more of the interest amount than the principal. Gradually, the interest component will reduce and the principal component will increase. You can understand the calculation with the following example:

If you have taken a home loan of ₹ 10,00,000 for a tenure of 10 years at an interest rate of 10%. The details of this case are mentioned in the table below

Methods of Loan Repayment

The most prevalent methods of loan repayment are mentioned below:

• Equated Monthly Instalments (EMI): This is the most prevalent and popular method of repaying debt. In this method, you are required to pay on a particular date of the month till the tenure of your loan. Your every instalment consists of some component of the principal and some of the interest. After a certain time, your lender can also give you the offer to prepay your loan.
• Bullet Payment option: Some lenders also offer a bullet payment system to their borrowers. In this payment method, you just need to pay the amount of interest every month and the principal components need to be paid after the end of the tenure of your loan in one go.

Types of Loans

Broadly loans could be classified into two types – Secured and Unsecured. They are discussed below.

• Secured loans: Secured loans are loans in which you have to provide an asset as a security for the loan to the lender. In case, if you are not able to repay the loan then the lender can take possession of your asset and can recover the loan. Examples of secured loans are home loans, gold loans, loans against property, etc.
• Unsecured loans: In this type of loan, there is no requirement for collateral or security. The lender can give you the loan based on your past credit history, credit score, etc. Here the rate of interest is higher than the secured loans. Examples are personal loans, education loans, etc.

Conclusion

The loan is an amount that you borrow from banks and financial institutions and promise to return in a fixed tenure. Loans are of two types i.e secured and unsecured loans. Loan repayment is a long process where you have to pay monthly instalments for a fixed timeframe.

Timely repayment of the loan is very important for maintaining a good credit score, credit history, and credibility as a borrower. By repaying your loans without any default you can apply for more loans with better interest rates in the future.

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