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When you're looking for a personal loan, there's a lot of details to consider -- from interest rates to credit score requirements. One extra fee you don't want to get stuck with is a prepayment penalty.
Here, we'll cover what a prepayment penalty is, when it's applied to a loan, and what you can do to avoid it altogether.
A prepayment penalty is a fee some lenders charge if you decide to pay your personal loan off early.
Lenders make their money from the interest paid on loans. When you pay a loan off earlier than expected, you end up paying less in interest. Some lenders see that as a breach of the original agreement. In other words, they loaned you money, but you didn't end up paying them back as much as they expected. They try to make up for that loss by charging a prepayment penalty.
No. Some of the best personal loans charge no prepayment penalty.
A prepayment penalty can cost you hundreds (or thousands) of dollars, so it's worth looking for a loan that won't charge that fee.
The exact fee varies by lender, loan type, and your specific loan agreement. Here are some types of prepayment penalty you might encounter:
Here are a few ideas to help avoid paying a prepayment penalty:
Loan shop. Talk to multiple lenders. Work only with lenders that don't charge a prepayment penalty -- regardless of credit score.
Join a credit union. If you have trouble getting approved by a lender that doesn't charge a fee, consider joining a credit union. Credit unions are far more interested in keeping you happy than the average lender, so your chances of avoiding a prepayment penalty are better.
Consider a secured loan. Some lenders will waive the fee if you take out a secured personal loan rather than an unsecured loan. A secured personal loan requires something of value that you own -- like a car, house, investment account, land, or jewelry -- as collateral in return for a loan.
Raise your credit score. Borrowers with high credit scores can sometimes negotiate loan fees. If you have a little extra time, try credit-raising strategies like checking your credit report for mistakes, asking for a higher limit on your credit cards, and paying off credit card debt.
Before signing a loan agreement, ask the lender these four questions:
If the lender does charge a prepayment penalty, read the prepayment penalty clause in the contract. If that clause sparks any more questions, ask before signing.
Here are some other questions we've answered:
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