What is Prepayment of Loans?
Prepayment of a loan is the repayment of a loan before the end of its loan tenure. Individuals usually end up making prepayments on their loan when they come in contact with a lump sum amount of money that can be used to prepay their loan. Prepayment can either be done in full or partial. Individual borrowers who expect to prepay their loans early should generally favour a combination of lower principal balance and higher interest rate (which stops accruing after prepayment), rather than a below-market interest rate and higher principal balance.
What is Prepayment Penalty on Loans?
Prepayment penalty is the penalty charged by the lender on prepayment of the loan. Terms and conditions regarding the prepayment penalty is mentioned in the loan clause. There are ‘soft prepayments’ and ‘hard prepayments’. In ‘Soft prepayments’, prepayment without penalty is allowed if the home is sold. ‘Hard prepayments’ come with a penalty without any exceptions.
How much does a Prepayment Penalty cost?
Prepayment penalty charged on prepayment of loans usually depends on the banks offering the loans. Most of the banks charge 1% of the prepayment loan amount as the prepayment penalty while other banks go as far as charging 2% to 4% of the prepayment loan amount. The prepayment penalty also depends on the prepayment loan amount, loan tenure and the interest rate on the loan
Why Prepay the Loan?
Prepaying the loan has a lot of benefits. Firstly, it takes the burden off of your shoulders. Secondly, when you pay off a loan earlier than the expected period, you will save up a lot of money as you will not be paying the interest for the whole loan term. But this is bad news for the banks as they make less money than anticipated when a loan is paid off early. Hence, to make up for the loss, banks charge prepayment penalty.
How to lower Prepayment Penalty?
There is no way to avoid prepayment penalty but that shouldn’t scare you away from prepaying your loan. Listed below are a few steps that you can follow in order to lower your prepayment penalty.
- Read the fine print
Read about the prepayment penalty terms and conditions thoroughly. Some banks charge a heavy prepayment penalty if you make prepayments soon after the first year of the loan. If you are close to hitting a reduced penalty threshold, wait for a few months before making the prepayment to reduce the prepayment penalty
Speak to your loan officer and try to negotiate the rates of your prepayment penalty. They will not dismiss your prepayment penalty but you might get a reduced prepayment penalty if you have a good relation with your bank.