6 October 2020
The loan is a liability and one of the core aspects of life that induces stress and keeps us financially captive. At times, destiny favors some of us and offers a chance to pay off the loan much in advance and feel relieved. Readers who are clearing loans every month, don’t you wish you were fortunate enough? You do, but let’s read about a major pain point, you might not be aware of the prepayment of loans.
A prepayment penalty in a loan contract clause states that when a borrower pays off the loan entirely or partially before term, a certain amount of penalty is applied on it. This clause helps the lender not lose their interest income that the borrower would have otherwise paid throughout the term.
The lenders are required to disclose the prepayment penalties before closing on a new loan of any sort. This helps make sure that the borrower is well informed in advance of the consequences that might entail when paying the loan off before term.
Prepayment penalties are placed in contracts to help compensate for the cost of lost income by the lender. Given a choice, a lender would rather lend to a borrower that pays exactly on time – not prior, or later – in order to generate maximum income from the interest. It’s why prepayment penalties have traditionally been put in place.
These penalties don’t just come into play when the borrower pays off the entire loan, but some of these also apply if a considerable part of the loan is paid as a single payment. Additionally, prepayment penalties can be used to recoup profits when the loan is advertised with below-average interest.
Lenders may calculate the penalty of the principal of the loan or how much interest remains once you’ve paid off the loan. The fee could also be a fixed amount that was decided upon when the loan was signed.
As mentioned earlier, the penalties can be calculated in various ways. It mostly depends on the kind of loan one has taken, a small personal loan, a substantial loan, or how the lender calculates it.
One must check how the penalties are being calculated to know if paying the loan off is beneficial. The various ways to calculate it are as follows:
The best way to avoid a prepayment penalty is to find a lender who wouldn’t or doesn’t charge a prepayment penalty on your loans. In case that is not difficult, make sure to ask relevant questions like, if it is for a certain number of years or the entire term of the loan? What percentage of the loan is considered for the penalty?
Besides this, there are other ways to prevent a prepayment penalty.
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