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    Loan Foreclosure and Its Impact on Your Credit Score

    Ask any average Indian who has taken a loan, “What will you do when you receive a windfall bonus or inheritance?” The most common answer will be something like this, “I will close my existing Housing Loan and become debt-free.” The feeling is quite reasonable. Can foreclosing your existing loans do any harm? Not many people know that foreclosing a secured mortgage can have a negative impact on your credit score.

    Is it not ironical that closing a loan account and reducing the liability brings down your credit score? Yes, it is, but that is how credit scores work. You should understand the working of the credit score mechanism before venturing to prepay your Home Loan. Let us see how a foreclosure can have an impact on your credit score.

    1.     Age of credit

    One of the defining factors in the computation of your credit score is the length of your credit history. Home Loans are long-term investments. Regular repayments of your Home Loans are perfect for maintaining your credit score. The longer your credit history, the higher is your credit score. It is because you leave a good and long trail of credit. It proves your financial stability and ability to deal with debt.

    Foreclosure of your home can result in reducing your average credit age. You save on your interest component, but end up hampering your credit score. It can affect your future credit. Remember, the more extended the period of your loan, the better is your credit score.

    2.   Affects the credit mix

    Proper repayment of your loans is an essential factor in determining your credit score. It is advisable to have a healthy mix of secured and unsecured loans. Banks and lenders like to see how you handle a variety of investments, both secured and unsecured. Your credit history should have a mixture of Personal Loans, Home Loans, Credit Cards, gold loans, and so on. The balance between the secured and the unsecured loans is an essential factor that determines your credit score. Foreclosing your Home Loan can alter the balance by drastically reducing your secured loans portfolio. It can result in an adverse secured to unsecured loans ratio and affect your credit score.  

    One must understand that banks and lenders prefer dealing with secured loans more than the unsecured ones. It is because they have the cushioning of the collateral in case of default. The banks can resort to selling the security to recover their advance. It also explains why the Home Loan Interest Rates are lower than the other loan products. The availability of collateral is the primary reason why lenders accept a lower credit score for Home Loan as compared to the Personal Loan.

    When you foreclose your secured loan, it affects the stability of your credit portfolio mix. It is better if you use the windfall gain to close unsecured loans like your education loan or your Personal Loans and Credit Cards.

    Look out for the prepayment penalty clause

    The prime objective of the banks is to earn interest on the loans they give. They give you the facility of repaying the loan in installments. When you foreclose your Home Loan, the bank gets its repayment before schedule. It affects their liquidity position. Of course, lenders want their money back, but not by way of foreclosures. They would prefer you to pay your EMIs (Equated Monthly Instalments) regularly on time. Banks can charge penalties if you make a prepayment. The Reserve Bank of India has mandated that banks should not charge a penalty on foreclosure of Home Loans under any circumstances.

    Foreclosing any loan reflects on your credit report. Any remarks about foreclosure of mortgages in your credit report can make the lender question your creditworthiness and make it difficult to obtain loans in the future. You might not be able to take advantage of the best housing loan offers because of the adverse remark in your credit history. Foreclosing a Home Loan can also affect the income tax concessions you receive on payment of home loan interest.

    A simple example to show how foreclosure can affect your credit score

    Let us assume you have a credit score of 700 with the perfect mix of secured and unsecured loans. You foreclose your home loan, and your credit score comes down to 675. Assume you do not apply for the best home loan offers and other investments for a specific period. Your credit score remains at 675. If you had not done the foreclosure but made regular repayments during this period, your credit score could have improved to 720. Therefore, it is better sometimes to use your windfall gains by investing elsewhere rather than foreclose your home loan.

    To apply online for Credit Cards, Secured Loans and Unsecured Loans, visit www.mymoneymantra.com, the leading online lending marketplace that offers financial products from 60+ Banks and NBFCs. We have served 2 million+ happy customers since 1989. 

    Talk to our Loan Specialists toll-free at 1800 103 4004 to know more about our products and offers. 

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