If you’re considering taking out a loan, beware of the prepayment fee. This fee is charged by the lender if you repay your loan early, and can often be quite hefty. So unless you’re absolutely sure you can repay your loan on time, it might be best to steer clear of loans with a prepayment fee.
What is a prepayment fee?
A prepayment fee is a charge some lenders levy if you pay back your loan earlier than the agreed term. This fee compensates the lender for any interest they would have otherwise earned had you stayed with the original repayment schedule. Find examples of lenders you can ask about prepayment terms here.
How do prepayment fees work?
The main purpose of a prepayment fee is to discourage borrowers from refinancing their loans every time rates drop by a fraction of a percent. Lenders make money off the interest you pay on your loan, so when you refinance your loan, they lose out on that income.
Prepayment fees are most common on mortgages, but they can also apply to other types of loans, such as auto loans and student loans. The amount of the fee varies depending on the lender and the type of loan, but it can be several thousand dollars.
If you have a loan with a prepayment fee and you want to refinance, you’ll need to factor in the cost of the fee when deciding whether it’s worth it. If rates have dropped significantly, it might still be worth refinancing even with the fee. But if rates have only decreased slightly, you might want to keep your current loan and avoid paying the fee.
What are the benefits of having a prepayment fee?
A prepayment fee is designed to compensate the lender for the interest that they would have earned had you kept the loan for the full term. In some cases, the prepayment fee may also cover other costs associated with originating and servicing the loan.
While having to pay a prepayment fee may seem like a negative, there are actually some benefits to be aware of. First, many lenders will waive the prepayment fee if you keep the loan for a certain number of years (typically 3-5 years). This means you can still benefit from paying off your loan early without having to pay any additional fees. Second, some lenders may offer a reduced interest rate if you agree to pay a prepayment fee. This can save you money over the life of the loan and make it more affordable in the short-term.
If you’re considering taking out a loan, be sure to ask about any prepayment fees that may apply. It’s important to understand all of the costs associated with the loan before making a decision.
Are there any disadvantages to having a prepayment fee?
While a prepayment fee on your loan may discourage you from refinancing your mortgage early, it could also potentially save you money in the long run.
If interest rates drop significantly shortly after you take out your mortgage, you may want to refinance in order to get a lower rate and lower monthly payments. However, if you have a prepayment fee, refinancing may not be worth it because the fee could cancel out any savings from the lower rate.
Additionally, even if there’s no prepayment fee, there may be other costs associated with refinancing, such as appraisal fees or loan origination fees. So be sure to compare the total cost of refinancing (including any fees) with the monthly savings you’d get from a lower rate before making a decision.
How can I avoid paying a prepayment fee?
If you’re within 10 years of taking out your loan, you may be hit with a prepayment fee if you sell or refinance your home. This fee is generally equal to 1-6% of your loan balance, but can vary depending on your loan terms. You may be able to avoid paying a prepayment fee by:
- Asking your lender to waive the fee. This is usually only possible if you have a good reason for wanting to sell or refinance, such as needing to move for work.
- Taking out a new loan with a different lender. You’ll still have to pay the original lender their prepayment fee, but you won’t have to pay any additional fees to the new lender.
- Waiting until you’re outside of the prepayment fee window. This is typically 10 years after taking out your loan, but can vary depending on your loan terms.
What happens if I prepay my loan without paying the prepayment fee?
If you have a variable rate loan and you prepay without paying the prepayment fee, you will still save on interest because you will be charged the lower, current interest rate on any remaining balance.
Can I negotiate the terms of my prepayment fee?
Your bank may be willing to negotiate the terms of your prepayment fee, especially if you have a good relationship with the bank. If you’re considering refinancing your loan, it’s worth asking your current lender if they’ll waive or reduce the fee.
What are some common misconceptions about prepayment fees?
When researching loans, you may come across the term “prepayment fee.” Some people mistakenly think this is a fee charged by the lender if you pay off your loan early. However, prepayment fees only apply to certain types of loans, and they’re not always charged by the lender.
Prepayment fees are typically associated with loans that have adjustable interest rates. These fees are designed to protect the lender if you choose to refinance your loan or sell your home before the end of the loan’s term. Since the lender would lose out on interest payments if you paid off your loan early, the prepayment fee compensates them for this loss.
Not all loans with adjustable interest rates have prepayment fees, so be sure to ask your lender about this before you agree to a loan. If you do have a prepayment fee, it will likely be a percentage of your loan’s total balance. For example, if you have a $100,000 loan with a 3% prepayment fee, you would owe $3,000 if you paid off the loan early.
Prepayment fees can also be charged on some fixed-rate loans, but this is less common. With a fixed-rate loan, the interest rate stays the same throughout the life of the loan, so there’s no risk to the lender if you pay it off early. As a result, prepayment fees are usually only charged on fixed-rate loans if they have terms of five years or less.
If you’re considering a loan with a prepayment fee, make sure you understand how it works before agreeing to anything. This way, there will be no surprises down the road.
What should I do if I have more questions about prepayment fees?
Prepayment fees are a way for your lender to recoup some of the costs associated with originating your loan. Because these fees are typically assessed when you pay off your loan early, they’re sometimes called “early termination” or “early payoff” fees.
If you have questions about prepayment fees, contact your loan servicer. They should be able to explain your options and help you calculate any potential fee.
How can I learn more about prepayment fees?
When you refinance your mortgage, you may be charged a fee by your lender if you pay off your loan early. This fee is called a “prepayment fee.”
Prepayment fees are common with adjustable-rate mortgages (ARMs). They’re also common with loans that have terms of less than five years, such as balloon loans and some subprime loans.
Prepayment fees are sometimes negotiable. If you’re not able to negotiate a lower prepayment fee, you may be able to finance the fee into your new loan.