A prepayment penalty is a fee some lenders charge when you pay off a loan early. It is intended to recover a portion of the interest the lender would have collected over the full term.
A prepayment penalty applies when you repay all or part of a loan ahead of the scheduled term, and it offsets interest income the lender would otherwise have earned. It may be calculated as a percentage of the remaining balance, a set number of months of interest, or a flat amount, and some penalties apply only within an early window of the loan. When a loan has no prepayment penalty, repaying early generally reduces the remaining interest and the total cost. Whether a loan includes a prepayment penalty, and how it is calculated, is stated in the loan agreement, so it is a clause customers commonly check before signing.
