Prepayment penalty

Before you rely on it

What to check

Read the note for how long the penalty applies and how it is calculated.

The common error

Where people go wrong with prepayment penalty

Refinancing without checking. The penalty on the old loan can consume most of the first year's saving on the new one, and it is discovered at closing.

Worked through

Prepayment penalty in plain numbers

A $200,000 loan carries a penalty of 2% on any amount repaid early during the first three years. Pay off $150,000 in year two and the fee is $3,000. Whether that is worth it depends on what you gain. Suppose refinancing into a cheaper loan saves $80 a month, and the break-even is $3,000 ÷ $80, or about 37.5 months. Stay past that and the refinance wins. Sell within it and the penalty costs you. Penalty formulas differ: some charge a percentage of the balance, others a number of months of interest, and some apply only to a full payoff, not to extra payments within an allowance.

Easily confused

Prepayment penalty and its neighbours

A prepayment penalty is not the same as a late fee, an origination fee or a due-on-sale clause; it is charged for repaying early, in full or in part. A soft penalty applies only if you refinance, while a hard one also applies if you sell. Yield maintenance and defeasance are commercial versions that compensate the lender for lost interest, and many consumer loans have no penalty at all, and rules limit them in some places and loan types. Read the note and the disclosure to see which kind applies.

In real decisions

Where prepayment penalty turns up

Borrowers check for one before making extra payments, refinancing or selling; lenders sometimes offer a lower rate in exchange for a penalty period; investors with commercial loans plan around them when timing a sale. A calculator adds the penalty to the cost of paying off early and compares it with interest saved. Asking for a loan without a penalty, or with a short penalty window, gives flexibility if plans change.

Know the edges

Where prepayment penalty stops being reliable

The terms live in the loan documents and can be complex; a penalty may apply to partial prepayments beyond an annual allowance. Laws on penalties differ by jurisdiction and product. Calculators simplify the terms. Confirm the exact amount with your lender in writing before you pay off a loan early.

Quick answers

What people ask about prepayment penalty

How do I find out if I have one? Check your loan note and the closing disclosure, or ask the servicer. The terms state the amount, the period and what triggers it.

Can I make extra payments without a penalty? Often, up to an annual allowance. Some loans charge only if you pay off the whole loan. Confirm the limit in writing.