What is Prepayment Penalty?
The Short Answer
Prepayment Penalty explained simply
A prepayment penalty is a fee that some lenders charge if you pay off your loan ahead of schedule. Lenders use these penalties to make up for the interest income they lose when a loan is repaid early. This is common in mortgages and business loans. The penalty amount can vary. It might be a percentage of the remaining balance or a fixed fee. Always check your loan agreement for these clauses.
Real-World Example
Business Loan Prepayment
Imagine a business takes out a $500,000 loan with a 10-year term. The loan agreement includes a 2% prepayment penalty for the first five years. If the business decides to pay off the remaining $300,000 balance in year three, they would owe a prepayment penalty of $6,000 ($300,000 * 0.02).
Why this matters
Prepayment penalties matter because they can add unexpected costs if you decide to pay off your loan early. This can impact your financial planning. Knowing about these penalties helps you make better decisions about refinancing or selling assets.
Always read the fine print on your loan documents. Prepayment penalties can be a hidden cost that impacts your ability to refinance or sell your business without extra fees.
Always read the fine print on your loan documents. Prepayment penalties can be a hidden cost that impacts your ability to refinance or sell your business without extra fees.
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