What Is a Prepayment Penalty on a Personal Loan?

Paying off a personal loan earlier than the final due date, also known as the loan maturity date, can be a smart financial move — reducing your interest costs and freeing up your budget. Prepayment is when you pay off your total loan balance before the loan maturity date, which appears in your loan agreement documents. However, depending on the terms of your loan, paying early might come at a cost. Some lenders charge a prepayment penalty if you pay off your loan ahead of schedule, which could sometimes reduce or even eliminate the savings you might get from paying early.

Understanding how a prepayment penalty works could help you make more informed decisions about how you plan to manage your loan payments to meet your financial goals.

What is a prepayment penalty?

A prepayment penalty is a fee that some lenders charge if you pay off your loan in full before the end of your repayment term, also known as the loan maturity date.¹

Your loan payments are calculated based on the principal (original amount borrowed) and interest (cost of borrowing) for the loan term you agreed to. When you pay off a loan early, the lender loses a portion of the interest they would have earned, which is one reason some lenders include the penalty in their loan agreements.

Lenders are required to be upfront about their fees and terms, so you should be able to find details about a potential prepayment fee — including the amount and when it takes effect — in your loan agreement.²

While penalty charges for paying off a loan early have become less common in recent years, it’s worth knowing what they are and how they may impact the way you manage your loan.³

How much does a prepayment penalty cost?

Each lender has their own way of calculating prepayment penalties. Here are some common ways, along with examples:⁴

• Fixed fee: A fee equal to a set dollar amount, no matter how much you pay off or how much you owe, such as a $500 penalty for early repayment.
• Percentage of the loan balance: A penalty fee based on the remaining loan balance. For example, if your lender charges a 2% fee on a $12,000 balance, you will pay $240.
• Lender’s lost interest: A penalty fee equal to the amount of interest the lender would lose when you pay the loan early. For instance, if you have a $10,000 loan with a 10% interest rate and a five-year term, you’ll owe around $2,750 in interest over the life of the loan. If you paid the loan off a year earlier, you would owe the lender around $550 in lost interest.

How to avoid a prepayment penalty

The best way to avoid a prepayment penalty on a personal loan is to read the fine print before you sign the loan agreement documents. If you find that the lender charges a penalty, you can still shop around to find a lender and terms that fit your needs. OneMain does not charge early payment fees and always provides clear loan terms upfront, so you know the total cost of borrowing ahead of time.

Don’t be afraid to ask questions if you’re unsure about the terms you’ve been provided or if your financial situation changes. Let’s say you’re already paying back a loan, and you get a windfall of money, like a big tax refund. You might consider using the funds to pay off the loan early. In this case, you should contact the lender to learn whether you’ll be charged a prepayment fee.

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Make the best borrowing decision for your money goals

Whether you’re planning to pay off an existing loan early or want to avoid prepayment penalties on a new loan, knowing your loan terms puts you in control. Having a clear understanding of your loan details may help you avoid unexpected fees, so you can make smart choices that support your financial goals.

Sources:

1,3 https://www.experian.com/blogs/ask-experian/what-are-prepayment-penalties/
2 https://www.justia.com/consumer/deceptive-practices-and-fraud/undisclosed-fees/
4 https://www.cnbc.com/select/what-is-prepayment-penalty-personal-loan/