Prepayment penalty.
In plain English
A prepayment penalty is a fee a lender charges when you pay off all or part of a loan ahead of schedule. Lenders make money on interest, so paying early cuts into their expected return, and the penalty is how some recover part of it. It is most common on mortgages and some auto and personal loans, and it can be a flat fee, a percentage of the remaining balance, or a set number of months of interest. Many loans have no prepayment penalty at all, so it is something to check before you sign.
01Why it matters
If you plan to pay a loan off early or refinance, a prepayment penalty can wipe out the interest savings you were chasing, so it pays to confirm the loan does not have one before signing.
02The math, step by step
You have a $20,000 loan and want to pay the remaining $15,000 off two years early. If the loan carries a prepayment penalty of, say, 2 percent of the balance, paying it off costs an extra $300 on top of the $15,000. Whether that still beats keeping the loan depends on the interest you would otherwise pay. Read your loan agreement for the exact penalty terms before deciding.
03What this is NOT
A prepayment penalty is the opposite of a late fee. A late fee punishes paying too slowly. A prepayment penalty charges you for paying too quickly. Both are spelled out in the loan agreement.
04Receipts
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Plain-English answers from our glossary. Receipts included. Never advice.
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