Does a Personal Loan Have a Prepayment Penalty?

Contrary to what most people think, paying off your personal loan monthly installment total ahead of time can result in prepayment penalty charges. So, yes – most lenders have a personal loan prepayment penalty. Many financing institutions and banks charge a penalty fee to borrowers when they pay every personal loan monthly installment before the end of their loan’s agreed term. Lenders use these fees to attenuate prepayment risks and prevent being deprived of the future interest payments that would have applied if the borrower respected the originally agreed terms. 

These “exit fees” are basically extra costs charged by the lending institution, enabling it to place the loan in a security and offer it for other institutions to buy. These institutions will normally require assurance that the loan will remain outstanding for a certain period so that they can be sure to receive a set yield for the security.

How Much is the Prepayment Penalty?

It is common knowledge that lenders, banks, and other financial institutions make the most of their profits from charging interest rates to borrowers. However, the terms on a personal loan might set a prepayment penalty for when the borrowed amount is paid off before every personal loan monthly installment has been completed.

The personal loan prepayment penalty will vary according to the borrowed amount and can be calculated by the borrower by multiplying the amount that remains on the loan by the penalty percentage set in the financing terms. Fees will normally be calculated in relation to the loan’s principal, or by how much interest remains to be paid at the time when the loan is paid off. The only way to anticipate these situations if you are planning to take on a loan and eventually paying every personal loan monthly installment ahead of time is to carefully compare loan options prior to borrowing any amount of money.

 Prepayment Fee Types

There are many types of prepayment fees. Some loans have what is known as a “hard prepayment penalty”, while others include a “soft penalty” within their terms. While paying off every personal loan monthly installment’s balance ahead of time or refinancing them can incur in a hard penalty, some refinancing options that lead to longer lending terms might result in a soft prepayment penalty. Luckily, there are a number of lenders that do not charge these fees when every personal loan monthly installment is canceled ahead of time.

Some examples of personal loan providers that do not charge prepayment penalty fees include Prosper (which also has only a one-time origination fee), Upgrade, LendingClub (which also offers loan terms of up to 5 years), Best Egg, Avant, Upstart, Payoff, and LendingPoint.

How a Personal Loan Prepayment Penalty is Calculated?

To get a better understanding of how big a personal loan prepayment fee can be, we can use as an example a $100,000 loan that is given with a 3/2/1 exit, which means that the borrower needs to pay a set amount at the time of closing the loan, in order to lessen the interest rates charged by the institution over the first three years of the loan’s payment term. In this case, the borrower’s interest rate will be 3% lower during the first year than the permanent rate, 2% lower during the second year, and 1% lower on the third. If they choose to pay off this loan in two years instead of three (and assuming that it is an interest-only loan), the exit fee would amount to 2% of the borrowed total: $2,000.

In all cases, lenders must clearly communicate if taking care of every personal loan monthly installment before the end of the term will incur in a penalty fee. The Truth In Lending Act reinforces this rule, pressing lenders to provide a document outlining every fee involved with a loan, including any eventual personal loan prepayment penalty. Normally, if the phrase “no prepayment penalty” is not found in the contract, it means that canceling your outstanding personal loan monthly installment total will carry a fee. However, if you already took a personal loan that has a prepayment penalty fee, in some cases you can sidestep the penalty by paying the loan off closer to the final due date.

In any case, you should always calculate the fee amount and carefully evaluate your options, as in many cases you can still save on interest fees in the long run, even when a personal loan prepayment penalty is involved.

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