Can a loan foreclosure spoil my credit score?

A wide range of loans are available in the market to cater to different needs of customers across categories. While loans come in different forms like personal, commercial, secured and unsecured, the borrower’s credit profile plays a crucial role in availing such loans. Loans can be availed for a range of needs like personal use, debt consolidation, new business ventures, renovations or investment. However, loan repayment and usage of credit facilities can significantly impact your credit score.

Loans are usually repaid through EMIs or bullet payment, while banks also offer the option to repay the loan EMIs through pre-payment or loan foreclosure facility.

What is loan foreclosure?

As the name suggests, loan foreclosure or pre-closure is basically a process where the borrower repays the outstanding loan amount before the end of the tenure. While foreclosure can provide relief from the interest payments and debts, one should also consider other factors like pre-closing charges, interests, and other financial situations.

Speaking about its benefits and impact, while it reduces interest payments and saves money, foreclosure of loans also impacts the credit score of borrowers.

How does loan foreclosure affect credit score?

While paying off a loan in advance can attract prepayment penalties and pre-closure charges for personal loans, it often affects the credit mix and reduces the credit score marginally. This usually happens in the case of first-time borrowers. Those who want to build a credit history should not opt for loan foreclosure and instead continue paying their EMIs regularly for a longer duration. This will help to improve the credit score and history, thus improving the eligibility for future loans.

Besides that, loans are sanctioned on the basis of a repayment schedule. Generally, lending institutions create EMI schedules after taking into account the protocols for asset liabilities management and foreclosing the loan can disrupt these calculations.

In case of foreclosure, banks are forced to let go of the interests, for which they charge a prepayment penalty fee. These details are often reflected in the credit report, affecting the borrower's credit score.

On the brighter side, loan foreclosure in some places can also prove to be beneficial for one's credit score as it is still considered a loan paid within a set tenure.