Prepayment of Loan

Prepayment of a loan refers to paying off all or part of a loan before its scheduled due date. Prepayments can save borrowers money by reducing the amount of interest paid over the life of the loan. Some loans, however, have prepayment penalties, which are fees charged for paying off a loan early. Prepayments are common for mortgages, personal loans, and business loans, allowing borrowers to reduce their debt burden more quickly.

Example

A homeowner makes an extra payment toward their mortgage principal each month, reducing the total interest paid and shortening the loan term through prepayment.

Key points

• Paying off a loan partially or fully before its due date.

• Can save money on interest over the loan’s life.

• Some loans may have prepayment penalties for early repayment.

Quick Answers to Curious Questions

What are the benefits of prepaying a loan?

Prepayment reduces the total interest paid and allows borrowers to become debt-free sooner.

Why do some loans have prepayment penalties?

Lenders charge penalties to offset lost interest income from borrowers who pay off loans early.

How does prepayment affect a borrower’s credit score?

Prepaying a loan can positively impact credit by reducing debt levels, but it may also temporarily lower scores if it shortens the length of credit history.