Definition – Prepayment Penalty
A prepayment penalty is a fee you’ll be required to pay if you pay back your loan ahead of the payment schedule that has been established for said loan. If your loan includes a prepayment penalty clause, you will be required to pay an additional fee for paying off debt early.
Prepayment penalties are placed into contracts to help ensure that the lender is able to recoup the interest they scheduled for the loan. Some loans are designed to last a specific amount of time. Thirty-year mortgages are a good example of this, although many types of loans come with time commitments.
If a borrower pays off a debt early, the lender loses out on the interest they would have received if the borrower paid according to schedule.
Prepayment penalties typically are based directly or indirectly on your current loan balance. The less you owe on your loan, the smaller the prepayment penalty will be. For example, if you have three months of payments left on your loan, you’ll pay less for your penalty than you would if you had three years remaining.
These penalties tend to be percentages of your loan’s remaining balance, although this is not the case with every prepayment penalty.
Prepayment penalties are not included in every loan, and they are becoming less common. It is recommended that you determine if there is a prepayment penalty clause before taking out a loan.
To learn more about personal loans, visit LiftCredit.com for a complete glossary of terms.