Prepayment penalty
A fee some lenders charge when you pay off a loan earlier than the agreed term, designed to recoup expected interest.
Reviewed May 2026.
Most modern personal loans, federal student loans, and conforming mortgages don't have prepayment penalties — paying off early just saves you interest with no extra cost. But certain loans do impose them, and the cost can be significant.
Where they still appear: subprime auto loans, some credit-union personal loans, jumbo and non-QM mortgages, SBA 7(a) loans with 15+ year terms (in years 1-3), and some commercial business loans.
The penalty is typically structured as a percentage of the prepaid balance — most commonly 1-5% in early years, declining to zero. For consumer loans, federal Truth in Lending rules require prepayment-penalty disclosure in the loan agreement; for SBA, commercial, and business loans, disclosure depends on the note, SBA program rules, state law, and the lender's documents. Either way, read the agreement carefully. If you're considering a large lump-sum payment, call the servicer first to ask for an exact 'payoff quote' — that number will include any applicable penalty.
PayoffMath angle. Prepayment penalties flip the standard 'pay extra to save interest' math. Even a small penalty can wipe out the interest savings on a partial prepayment — confirm the penalty schedule before any extra-payment plan on a non-standard loan.
Why it matters. If your loan has a prepayment penalty, the optimal payoff strategy changes. Sometimes the right move is to hold the loan until the penalty schedule expires, then pay off in full — counterintuitive but correct.
Common mistake. Reading the rate and not the penalty schedule. A loan with a great rate and a 5% prepayment penalty in years 1-3 can lock you out of refinancing even if rates drop materially.
Try the sba loan payoff calculator → — model an SBA 7(a) loan where prepayment penalties are still common in early years.
Worked example
See also
Sources and review
Reviewed May 2026. Glossary entries are plain-language definitions, not legal definitions. For account-specific rules, your loan documents control.
Definition by James L. Wu. Plain-language gloss, not a legal definition. For terms that show up in your loan paperwork, the governing language is in your loan documents. See the editorial policy for sourcing.