What is a penalty for prepayment of a personal loan?


What is a personal loan prepayment penalty?

A prepayment penalty is a commission that some lenders charge if you decide to prepay your personal loan.

Why lenders charge prepayment penalties

Lenders earn their money from interest paid on loans. When you pay off a loan early, you pay less interest. Some lenders see this as a violation of the original agreement. In other words, they loaned you money, but you didn’t end up paying them back as much as they expected. They try to compensate for this loss by imposing a prepayment penalty.

Do all personal loans have a prepayment penalty?

No. Some of the best personal loans do not charge any prepayment penalties.

How much is a personal loan prepayment penalty?

A prepayment penalty can cost you hundreds (or thousands) of dollars, so it’s worth looking for a loan that won’t charge these fees.

The exact fees vary depending on the lender, the type of loan, and your specific loan agreement. Here are some types of prepayment penalties you might encounter:

  • A package
  • A percentage of the loan balance
  • Interest the lender will miss because you prepaid the loan

How to avoid paying a prepayment penalty

Here are some ideas for avoiding paying a prepayment penalty:

Loan Shop. Talk to several lenders. Only work with lenders who don’t charge a prepayment penalty, regardless of your credit rating.

Join a checkout. If you’re having trouble getting approval from a lender that doesn’t charge a fee, consider joining a credit union. Credit unions are much more interested in satisfying you than the average lender, so your chances of avoiding a prepayment penalty are better.

Consider a secured loan. Some lenders will waive the fee if you take out a secured personal loan rather than an unsecured loan. A secured personal loan requires something of value that you own – such as a car, house, investment account, land, or jewelry – as collateral in exchange for a loan.

Increase your credit score. Borrowers with high credit scores can sometimes negotiate loan fees. If you have a little extra time, try credit boosting strategies like checking your credit report for errors, asking for a higher limit on your credit cards, and paying off credit card debt.

Questions to ask your lender about prepayment penalties

Before signing a loan agreement, ask the lender these four questions:

  1. Do you charge a prepayment penalty?
  2. How do you calculate the penalty?
  3. What is the maximum amount that can be charged if I prepay the loan?
  4. Are you ready to negotiate the penalty?

If the lender charges a prepayment penalty, read the prepayment penalty clause in the contract. If this clause gives rise to further questions, ask them before signing.

Still have questions ?

Here are some more questions we answered:

Previous Why are student loan borrowers being left out of the coronavirus recovery?
Next Retiring With An Unpaid TSP Loan? Here's what you need to know