What Are Personal Loan Prepayment Penalties?
A prepayment penalty is a fee some lenders charge when you pay off a loan before the end of your term. Paying off a loan early saves you money on interest, but a prepayment penalty can offset some of those savings. These fees are not common on personal loans, but they do exist. Here’s what to know before you pay off a loan early.
What are prepayment penalties and why do they exist?
Lenders make money by charging interest, something they can only do while your loan is active. That’s why you, the borrower, can save on overall interest by paying off your loan early.
The lender, on the other hand, loses profit in this scenario. As a result, they might charge a prepayment penalty to discourage borrowers from paying ahead. Prepayment penalties can help lenders replace some of the interest they would have collected while your loan was still active.
Prepayment penalties are rare on personal loans. None of our top picks for the best personal loans charge one, and most major lenders allow you to pay off early at no extra charge.
They are more often found on other types of loans — particularly non-qualified mortgages and some auto loans, though federal regulations have made them less common overall.
How do personal loan prepayment penalties work?
Prepayment penalties usually come in four forms:
- Flat fee: A lender could have a flat fee as a prepayment penalty. For instance, they might charge you an extra $500 if you pay off your loan before the end of your term, regardless of your loan balance.
- Percentage-based fee: Some lenders charge a percentage of your remaining loan balance, often 1% to 2%, though it can be higher. For example, if your lender charges 2% and you have $10,000 left on your loan, your prepayment penalty would be $200.
- Months of interest: You pay a set number of months’ worth of interest on your remaining balance. This is commonly three to six months. The further you are from your payoff date, the larger this fee tends to be.
- Sliding scale: The penalty decreases over time as you get closer to your payoff date. For example, a lender might charge 3% in the first year, dropping to 2% in year two and 1% after that.
Prepayment penalties are sometimes weighted more heavily at the start of your loan and decrease over time. A lender may charge less (or nothing) if you’re only a few months from your final payment, since there’s little interest left to collect.
How do you know if your personal loan has a prepayment penalty?
You can usually find a lender’s fee schedule on its website. If it’s hard to find, take note — lack of transparency is a red flag. FAQs are also a good place to find information about fees.
If you have a personal loan but aren’t sure if it has a prepayment penalty, check your promissory note. This is the contract you signed during closing. If you find a clause indicating a prepayment penalty, it is part of your loan agreement and will apply.
You could also call your lender and ask for a loan payoff statement. That document will show whether your personal loan has a prepayment penalty.
Is it worth paying off a personal loan with a prepayment penalty?
Some simple math can help you figure out if paying early is worth it. Here’s an example using a $25,000 loan at 16.00% APR on a five-year term.
| Amount | |
|---|---|
| Total interest (full term) | $11,477 |
| Interest savings (pay off in 3 years) | $2,174 |
| Prepayment penalty (5% of remaining balance) | $599 |
| Net savings after penalty | $1,575 |
In this example, paying early still makes sense. Even after paying the $599 penalty, you’d still save about $1,575.
Use LendingTree’s personal loan calculator to run the same math on your own loan.
Does paying off a personal loan affect your credit score?
Whether you pay off a personal loan on time or early, it can cause a temporary dip in your FICO Score. If you’re planning a major financial move, like applying for a mortgage or auto loan, it may be worth waiting until after that transaction to pay off your loan early.
Paying off your loan (early or not) can impact the following factors — two of which may cause a temporary dip, and one that could work in your favor:
- Length of credit history: The length of your credit history makes up 15% of your FICO Score. If your personal loan is one of your oldest accounts, your score may drop slightly after you close it.
- Credit mix: Credit mix makes up 10% of your score. It measures the variety of debt you carry, such as credit cards and installment loans. If your personal loan is your only installment loan, your credit mix will be less varied once it’s paid off.
- Debt-to-income ratio: Debt-to-income (DTI) ratio isn’t part of your FICO Score, but most lenders consider it. It represents how much you earn versus how much you owe each month. Paying off your loan removes one monthly payment from the equation, which can improve your DTI.
How can you avoid personal loan prepayment penalties?
Here are two ways to avoid personal loan prepayment penalties before you borrow.
- Improve your credit score: Generally, borrowers with lower credit scores tend to see more fees on their loans. Check your credit score for free with LendingTree. If your score is below 670, you might want to improve your credit score before applying.
- Compare lenders: Just because some lenders charge a prepayment penalty doesn’t mean they all do. Prequalify for several loans by using LendingTree’s loan marketplace. Checking rates (and fees) won’t impact your credit score.
If you’re still shopping for a loan, you may be able to ask the lender to waive or reduce the prepayment penalty, especially if you have strong credit. Once you’ve signed the loan agreement, lenders aren’t obligated to make changes to your agreement, though you can always ask.
What other fees can apply to personal loans?
Unless you’re with a lender that charges no required fees (like LightStream and SoFi), you could owe any of the fees below.
Origination fee
An origination fee is an upfront fee. Upfront doesn’t usually mean out-of-pocket, though. Instead, the lender will typically deduct the fee from your loan proceeds before sending them to you.
Some lenders don’t charge origination fees. Those that do could apply one to every loan. Others might only charge an origination fee if you have fair or bad credit.
Late payment fee
You might get a fee for missing payments. Some late fees are a flat dollar amount. Others are a percentage of the late payment.
Many lenders extend a grace period for late payments. You might only be responsible for a late fee if you are five, 10 or 15 days past your due date. For specifics, check your loan documents or ask your lender directly.
Check payment fee
Some personal loan lenders charge a fee every time you pay by check to cover payment processing costs.
Returned payment fee
If you make a payment by check (either manually or through autopay) and that check bounces, your lender may charge a fee.
Application fee
Of all the fees on this list, application fees are probably the least common — and can be a sign of predatory lending. If a lender wants to charge you to apply for a personal loan, consider other lenders instead.
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