Prepayment Penalty

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Definition of 'Prepayment Penalty'

A prepayment penalty is a fee charged by a lender when a borrower pays off a loan early. The fee is designed to compensate the lender for the lost interest income that would have been earned if the loan had been repaid over its full term.

Prepayment penalties are most common on mortgage loans, but they can also be found on other types of loans, such as auto loans and personal loans. The amount of the prepayment penalty will vary depending on the type of loan, the lender, and the terms of the loan.

Prepayment penalties can be a significant cost, so it is important to be aware of them before you take out a loan. If you are considering paying off your loan early, you should compare the cost of the prepayment penalty to the interest savings you would realize by paying off the loan early. In some cases, it may be more cost-effective to simply keep making your regular payments and wait until the loan matures.

There are a few exceptions to the rule that prepayment penalties are always charged. Some lenders offer no-prepayment-penalty loans, which means that you can pay off the loan early without being charged a fee. Additionally, some states have laws that limit the amount of prepayment penalties that lenders can charge.

If you are considering taking out a loan, be sure to ask the lender about their prepayment penalty policy. This information should be disclosed in the loan agreement. You should also read the loan agreement carefully to understand all of the terms and conditions of the loan, including the prepayment penalty.

Here are some additional things to keep in mind about prepayment penalties:

* Prepayment penalties are typically only charged on loans that are amortized over a long period of time, such as 30-year mortgages. Loans that are amortized over a shorter period of time, such as 15-year mortgages, typically do not have prepayment penalties.
* Prepayment penalties are usually only charged for a certain period of time, such as the first five years of the loan. After that, the lender may no longer be able to charge a prepayment penalty.
* Prepayment penalties can be waived, but this is rare. If you are able to get a prepayment penalty waived, it will usually require you to pay a higher interest rate on the loan.

Prepayment penalties can be a significant cost, but they can also be avoided. By understanding how prepayment penalties work, you can make an informed decision about whether or not to take out a loan with a prepayment penalty.

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