Definition
A prepayment penalty is a fee charged by a lender for paying off the loan balance ahead of the schedule dictated in the contract.
Analysis
Some loan products contain prepayment penalties for making advance payments on a loan. A prepayment penalty is designed to ensure lender profits regardless of whether the consumer pays the loan off early or on-time.
Most loan products do not contain prepayment penalties. Some predatory loan products do contain such clauses, which further punishes lower-income consumers that often obtain these loans.
The result is that a person punished with a higher rate due to a higher risk factor would also be punished with a prepayment penalty. A borrower with demonstrated creditworthiness could prepay their loan with no penalty.
Consumers should review their loan contract to ensure that no prepayment penalty clause exists.
