Are you planning on paying off a loan early? Wait a minute and give it one more thought. Why? Because there are chances of you getting charged with a prepayment penalty. I know you might be in a happy mood, having gained that financial stability that you have been dreaming of. But there is a motive behind it.
A prepayment penalty is a fee that the lenders charge to regain the money they would otherwise lose when you are no longer paying interest on the loan. That interest is how they earn their bread and butter.
But here’s good news for you. You can avoid bearing the expenses of pre-penalty. You might be wondering how? Read on to know about it.
Before getting into how you can avoid getting a prepayment penalty, let us first see a prepayment penalty in detail.
What is a Loan Prepayment Penalty?
Lenders charge a certain fee if you are paying off a loan early. This prepayment becomes applicable to you only if you decide the entire balance.
For example, it applies if you decide to sell your car or to refinance your mortgage within a specific timeframe. Sometimes, the prepayment penalty gets used if you choose to pay off your loan of large amounts all at once.
Suppose you pay an extra principal amount in small chunks at a time. In that case, the prepayment penalty does not usually apply. It is always good if you double-check with the lender and also check your loan agreement.
How Can You Find Out If Paying off a Loan Early Affects You?
The best way for you to not fall into the trap of prepayments is to read your contract. Suppose you feel you would not ascertain that you won’t be missing out on essential details.
In that case, you can contact a professional such as an attorney or CPA. The professional can understand the terminology and would be able to review it. Sometimes the lenders try to hide the entirety of the loan, so you have to read it carefully. It is usually under the repayment terms or in the information that deals with the payoff of the loan or selling of your house.
Be wary of these alternative terms a lender could use in the contract:
- Sale before a specific timeframe.
- Refinance before a period.
- Prepayment before maturity.
The word penalty is usually avoided because it would give the taker or reader the loan or mortgage some alarm.
When negotiating terms for an auto loan, do not let a salesperson pressure you into signing a contract without any agreement to a simple interest contract with no prepayment penalty.
Start applying for a pre-approved auto loan so that you can be pro at reviewing any contracts before you sign.
When a lender provides you with a contract which includes a prepayment penalty, ask the lender not to have a prepayment penalty. However, the new agreement might make that loan less advantageous. But, you can compare the options and make a better choice.
Now that you know how to check whether a loan has a prepayment penalty let us look into what you can do about it.
What To Do If You Carry A Loan With A Prepayment Penalty?
Once you discover that you have a loan with a prepayment penalty, here is what you can do.
- First, check your contract.
- Make it a point to pay off your loan until the penalty period expires if you find out that you would be incurring a fee while you pay off your loan early.
- Though you may be hit with a penalty for paying off a loan early, you might still be making extra payments towards the balance. Thus, it is essential to review your contract or get to know from your lender what amount would trigger the penalty.
- In case you are paying multiple types of debt, choose to pay off the accounts that do not trigger any prepayment penalties. Credit cards and federal student loans do not charge any kind of prepayment penalties.
- Try using techniques such as debt avalanche, debt snowball and debt lasso methods. With this, you can tackle your other debts if you have, and at the same time, you would be giving the penalty period to expire.
Now that you know how to detect a prepayment penalty after you decide for paying off a loan early and what to do when you find it, you must make informed choices the next time you take a loan.