What Is a Prepayment Penalty on a Personal Loan?
Written by
Karen Doyle
Edited by
Melanie Grafil
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A prepayment penalty is a fee you may pay if you pay off a personal loan in full early. Some lenders charge a prepayment penalty to recoup some or all of the interest they would have earned if you had continued to pay the loan until the end of its term.
How Prepayment Penalties Work on Personal Loans
When you take a personal loan from a bank or other lender, they expect to earn a certain amount of interest, based on the amount and term of the loan, and the interest rate. If you pay the loan off earlier than required, they will get less interest. For this reason, a bank or other lender may charge you a penalty for paying the loan off early.
When you take out a loan, it’s important to understand if there is a prepayment penalty applies, and how it works. The penalty may apply no matter how you prepay — whether you send a little extra every month or pay a lump sum at the end. It may only apply during the first few years of the loan.
The prepayment penalty can be calculated in several different ways. It may be a flat fee of, say, $200 or $500. It may be the equivalent of a certain number of months’ worth of interest. Or it may be a percentage of the remaining loan balance.
How To Tell if a Personal Loan Has a Prepayment Penalty
It should be noted in the agreement in a section titled “early payoff” or “prepayment.” It should indicate the following:
- If there’s a penalty for paying off the loan early
- The penalty amount
- How it’s calculated
- Whether there’s a time period when it applies, e.g., the first three years of the loan
If the agreement does not mention a prepayment penalty, don’t assume there isn’t one. Ask the lender specifically and ask them to point out in the agreement where it’s indicated.
How Much Could a Prepayment Penalty Cost?
On a loan with a remaining balance of $5,000, if the prepayment penalty is 2% of the remaining balance, the penalty you would pay for paying it off early is $100.
How To Avoid Prepayment Penalties on Personal Loans
Avoiding a prepayment penalty is easy. Since many lenders don’t, it should be fairly easy to find one, and you can always ask the lender to be sure. Of course, the best way to do so is to choose a lender that does not charge a prepayment penalty at all.
You can also wait to pay off the loan until the penalty period ends. If your loan does have a penalty, it may only apply for the first few years of the loan.
Read your loan agreement carefully before you sign it so you’ll know the terms of your prepayment penalty, if there is one.
Is It Worth Paying the Prepayment Penalty?
In some situations, it can be worth it to pay your loan off early, even with a prepayment penalty. You’ll have to do a little math to figure out if this is the case for your loan.
- Figure out the amount you would pay in a penalty.
- Next, figure out how much you’d pay in interest if you pay the loan according to the original terms.
- If the penalty is less, go ahead and pay the loan off and pay the penalty.
- You may not pay the same amount in interest each month, though, as the interest part of your payment may decline over time.
- Make sure you’re using the actual interest you’ll pay in the future.
Best Personal Loan Lenders with No Prepayment Penalties
If you’re looking for a personal loan with no prepayment penalty, here are some lenders to consider.
| Lender | Prepayment Penalty | Key Features |
|---|---|---|
| SoFi | None | No fees, unemployment protection, large loan amounts |
| PenFed Credit Union | None | Good rates, flexible terms |
| Marcus by Goldman Sachs | None | No fees at all, flexible payment options |
| LightStream | None | Low rates for good credit, fast funding |
| Upgrade | None | Accepts fair credit, credit-building tools |
| Avant | None | Works with lower credit scores, quick funding |
| TD Bank | None | Low rates for excellent credit |
Prepayment Penalty on Loans FAQ
Need to learn more? Take a look at the answers to these frequently asked questions about prepayment penalties on loans.- What is a prepayment penalty on a personal loan?
- A prepayment penalty is a charge you pay if you pay the loan off early. Lenders may charge you as a way to make up for the interest that they would otherwise have earned.
- Do all personal loans have prepayment penalties?
- No. In fact, personal loans without a prepayment penalty are more common than those with one.
- Can I negotiate a prepayment penalty before signing?
- Typically not. Lenders have standard terms for the loans they make, and it's unlikely they will negotiate with you.
- How do I calculate my total savings if I pay early?
- Your loan agreement should indicate the total amount of interest you will pay if you pay the loan according to the terms. Add up the interest you've already paid and subtract it from the total interest to see how much you'd save by paying early.
- Are there personal loan lenders with no fees at all?
- Yes. Many lenders offer loans with no origination fees and no prepayment fee. Most lenders will charge a fee if a payment is late or is returned by your bank.
