So you took out a loan to grow your business, and things went so well you paid everything back early. Sounds great, right? Not if you run into a prepayment penalty. A loan prepayment penalty is an extra fee charged when you pay off your balance ahead of schedule. It could be a fixed amount or a percentage of your total loan. The penalty might only apply for a certain number of years, too.
For example, a lender could charge a 3 percent penalty if you pay back the loan within the first five years. If you borrow $100,000 and pay it back early, you’d owe an extra $3,000 for the penalty.
While it might seem like you’re doing lenders a favor by giving them their money back early, they were actually counting on you to keep the loan out the entire time, so you could keep paying them interest month after month. The loan prepayment penalty makes up for their lost income.
Any Way to Take an Early Exit?
There are many types of small business loans, and not all of them come with this penalty. The fee usually shows up with traditional lenders that use a longer loan application process. Since they spend more time approving your business and setting up the loan, they need to earn at least some amount to stay profitable.
Alternative small business lenders with faster applications do not charge this fee as often since they get each customer going more quickly.
With that said, there are some traditional lenders that skip this fee and some alternative lenders that charge it. Be sure to ask before you sign up. Paying back a loan early should be celebrated, so if you’d like the option for a cost-free early exit, avoid loans with this penalty.