In the Truth in Lending Act's closed-end credit rules, a "prepayment penalty means a charge imposed for paying all or part of the transaction's principal before the date on which the principal is due," subject to limited exceptions.
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.
