Prepayment Penalty on a Personal Loan: How can it be avoided?

Prepayment penalty is a fee imposed on borrowers when they prepay their loans. The lender could charge a prepayment penalty if you pay off your loan earlier than the scheduled date as mentioned in the contract.

You can be charged a prepayment penalty once you have paid off your debt, if it was paid early, or if you paid more than the scheduled amount per year. You may be charged a prepayment penalty based on the remaining balance of the loan, or you may be charged a fixed amount. 

You may be able to pay off 20% extra on some loans each year before being charged a fee. The high-interest costs and EMI burden associated with personal loans may cause borrowers to consider prepaying or foreclosing and prepay their existing ones. 

Personal loan prepayment can indeed be advantageous to borrowers in most cases. However, borrowers ought to conduct a thorough cost-benefit analysis before making a prepayment to ensure that they are making an informed decision.

How are prepayment penalties calculated?

Depending on the amount of the loan and the method used by the lender to calculate the penalty, the prepayment penalty cost can vary widely. Lenders use different methods to determine how much a prepayment penalty will be. To determine whether paying a prepayment penalty outweighs the advantages of paying early on your loan, you need to know how much the penalty will cost.

Methods of calculating a prepayment penalty

Before knowing how to get a personal loan, it is very important to know the various methods of calculating prepayment penalty

Interest costs

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The lender will charge you a prepayment penalty based on the interest you would have paid if you had paid the loan over its full term. 

Balance as a percentage

Penalty fees may be determined by a percentage of the remaining loan balance. For example, imagine you have paid half of your small personal loan but wish to repay the remainder early. In this case, your lender may require you to pay some percentage on a portion of the remaining balance as a penalty.

Flat fee

Depending on the lender, some may impose a simple flat fee as a prepayment penalty. If you want to pay back your loan early, you will always have to pay the prepayment penalty amount stated in your loan agreement, regardless of whether you repay your loan early or not.

Avoid a prepayment penalty

Even though it may seem like trying to avoid prepayment penalties is futile, it is possible to avoid them. Assuming that you already have a personal loan with a low personal loan interest rate and a prepayment penalty and you are interested in paying it off early, you should contact your lender. Your lender may offer you the possibility of paying off your loan closer to the end of the term, avoiding the penalty. 

Even if you contribute to the principal amount early and incur a liability, you might find that the penalty is less than the interest you would have paid over the remainder of the loan term. It would be a good idea to review your loan origination paperwork to see if it permits a partial payoff without incurring penalties. Depending on how your loan works, you may be able to prepay a portion of your loan each year, which can help you get out of debt faster without having to pay a penalty fee.

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Some lenders shift the terms of their prepayment penalties over the life of your loan. Depending on how close you get to the end of the original loan term, you may encounter lower prepayment penalties or no fees in the event of a prepayment. If that is the case, there may be some benefit in waiting a year or two until the prepayment penalties are reduced or no longer apply. It would be best if you didn’t make any assumptions about your money.

Final Thoughts

Prepaid personal loans are considered a very attractive proposition for borrowers, as they allow them to reduce their interest fees and overall repayment burdens. However, if the lender charges prepayment charges, and if the borrower loses liquidity, the possibility of incurring prepayment charges could deter the borrower. When borrowers have limited liquidity, they can reduce their repayment burdens and interest costs by transferring their personal loan to lenders that offer lower interest rates for personal loans.

Read Also: Advantages of Prepayment and Part Payment of Personal Loan

Author Bio

I am Zoya Arya, and I have been working as Content Writer at Rananjay Exports for past 2 years. My expertise lies in researching and writing both technical and fashion content. I have written multiple articles on Gemstone Jewelry like Monstone Ring and other stones over the past years and would love to explore more on the same in future. I hope my work keeps mesmerizing you and helps you in the future.

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