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How to Avoid a Prepayment Penalty When Paying Off a Loan

“It’s more of private loans — loans for people who’ve maybe had some struggles and can’t qualify for a Fannie or Freddie loan,” Gallagher said. “That block of lending is the one going to be most hit by this.”
You can also ask your lender about the terms regarding your penalty by calling the number on your monthly billing statement or read the documents you signed when you closed the loan — look for the same terms mentioned above.
A prepayment penalty is a fee lenders use to recoup the money they’ll lose when you’re no longer paying interest on the loan. That interest is how they make their money.
”The more opportunistic and less fair lenders would be the ones who would probably be assessing [prepayment penalties] as part of their loan terms,” he said, “I wouldn’t say loan sharking… but you have to search down the list for a less preferable lender.”
If you’re paying off multiple types of debt, consider paying off the accounts that do not trigger prepayment penalties — credit cards and federal student loans don’t charge prepayment penalties.
So suppose you bought a house last year and then wanted to sell your home. If your mortgage meets all of the above criteria and has a prepayment penalty clause in the mortgage contract, you could end up paying a penalty of 2% on the remaining balance — for a loan you still owe 0,000 on, that comes out to an extra ,000.

What Is a Loan Prepayment Penalty?

Gallagher rattled off a list of alternative terms a lender could use in the contract, including:
But you can avoid the trap — or at least a big payout if you’ve already signed the loan contract. We’ll explain.
However, if there is a prepayment penalty in the contract for a more recent mortgage, there are rules about how long it can be in effect and how much you can owe.
Additionally, although you may get socked with a penalty for paying off the loan balance early, it’s likely you can still make extra payments toward the balance. Review your contract or ask your lender what amount will trigger the penalty, Gallagher said.

What Loans Have Prepayment Penalties?

If you don’t have a loan with a prepayment penalty, contact your lender before sending additional money to ensure your payment is going toward principal — not interest or fees.

Now wait just a minute, you say. I’m paying the money back early — early! — and my lender thanks me by charging me a fee?
In some cases, a prepayment penalty could apply if you pay off a large amount of your loan all at once.

Pro Tip
Credit unions and banks are your best options for avoiding loans that include prepayment penalties, according to Charles Gallagher, a consumer law attorney in St. Petersburg, Florida.

By using techniques like the debt avalanche, debt snowball and debt lasso methods, you can tackle your other debts while giving yourself time to let a prepayment penalty period expire.

Prepayment Penalties for Mortgages

Typically, a prepayment penalty only applies if you pay off the entire balance – for example, because you sold your car or are refinancing your mortgage – within a specific timeframe (usually within three years of when you accepted the loan).
Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Read her bio and other work here, then catch her on Twitter @TiffanyWendeln.
Good for you! Except… make sure you don’t get charged a prepayment penalty.
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.

  1. The loan has a fixed interest rate.
  2. The loan is considered a “qualified mortgage” (meaning it can’t have features like negative amortization or interest-only payments).
  3. The loan’s annual percentage rate can’t be higher than the Average Prime Offer Rate (also known as a higher-priced mortgage).

Although you’ll find prepayment penalties in auto and personal loans, a more common place to find them is in home loans. Why? Because a lender who agrees to a 30-year mortgage term is banking on earning years worth of interest to make money off the amount it’s loaning you.
“You should read the entirety of the loan, as painful as that sounds, because lenders may try to hide it,” Gallagher said. “Generally, it would be under repayment terms or the language that deals with the payoff of the loan or selling your house.”
Prepayment penalties do not normally apply if you pay extra principal in small chunks at a time, but it’s always a good idea to double check with the lender and your loan agreement.
If your lender presents you with a contract that includes a prepayment penalty, request a loan that does not include a prepayment penalty. The new contract may have other terms that make that loan less advantageous (like a higher interest rate), but you’ll at least be able to compare your options.

How to Find Out If a Loan Will Have a Prepayment Penalty

First, check your contract.
A prepayment penalty is a fee lenders charge if you pay off all or part of your loan early.
“They avoid using the word ‘penalty,’ obviously, because that would give a reader of the note, mortgage or the loan some alarm,” he said.

  • Sale before a certain timeframe.
  • Refinance before a term.
  • Prepayment prior to maturity.

Do you have less-than-sterling credit? Watch out for pre-computed loans, in which interest is front-loaded, ensuring the lender collects more in interest no matter how quickly you pay off the loan.

If you’re negotiating the terms — as say, with an auto loan — don’t let a salesperson try to pressure you into signing a contract without agreeing to a simple interest contract with no prepayment penalty. Better yet, start by applying for a pre-approved auto loan so you can get a pro to review any contracts before you sign.

Pro Tip
If a loan has a prepayment penalty, the servicer must include information about the penalty on either your monthly statement or in your loan coupon book (the slips of paper you send with your payment every month).

The prepayment penalty won’t apply to FHA, VA or USDA loans but can apply to conventional mortgages — although the penalty is much less common than it was before the CFPB’s ruling.

How Can You Find Out if Your Current Loan Has a Prepayment Penalty?

If you’ll incur a fee for paying off your loan early within the first few years, consider holding onto the money until the penalty period expires.
The Consumer Financial Protection Bureau ruled that for mortgages made after Jan. 10, 2014, the maximum prepayment penalty a lender can charge is 2% of the loan balance. And prepayment penalties are only allowed in mortgages if all of the following are true:

What to Do if You’re Stuck in a Loan With Prepayment Penalty

Unfortunately, if you have bad credit and can’t get a loan from traditional lenders, private loan alternatives are the most likely to include the prepayment penalty.
The best way to avoid a prepayment penalty is to read your contract — or better yet, have a professional (like an attorney or CPA) who understands the terminology, review it.
Look at you, so responsible. You received a financial windfall — stimulus check, tax refund, work bonus, inheritance, whatever — and you’re using it to pay off one of your debts years ahead of schedule.

Pro Tip
Most loans do not include a prepayment penalty. They are typically applied to larger loans, like mortgages and sometimes auto loans — although personal loans can also include this sneaky fee.

Prepayment penalties apply for only the first few years of a mortgage — the CFPB’s rule allows for a maximum of three years. But again, check your mortgage agreement for your exact terms.
If you do discover that your loan includes a prepayment penalty, you still have some options.
That prepayment penalty can apply if you want to pay off your loan early, sell your house or even refinance, depending on the terms of your mortgage.
If your loan includes a prepayment penalty, the contract should state the time period when it may be imposed, the maximum penalty and the lender’s contact information.

Well, in some cases, yes.
Source: thepennyhoarder.com

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All About Car Loan Amortization

All About Auto Loan Amortization

These days, it can take a long time to pay off a car loan. On average, car loans come with terms lasting for more than five years. Paying down a car loan isn’t that different from paying down a mortgage. In both cases, a large percentage of your initial payments go toward paying interest. If you don’t understand why, you might need a crash course on a concept called amortization.

Find out now: How much house can I afford?

Car Loan Amortization: The Basics

Amortization is just a fancy way of saying that you’re in the process of paying back the money you borrowed from your lender. In order to do that, you’re required to make a payment every month by a certain due date. With each payment, your money is split between paying off interest and paying off your principal balance (or the amount that your lender agreed to lend you).

What you’ll soon discover is that your car payments – at least in the beginning – cover quite a bit of interest. That’s how amortization works. Over time, your lender will use a greater share of your car payments to reduce your principal loan balance (and a smaller percentage to pay for interest) until you’ve completely paid off the vehicle you purchased.

Not all loans amortize. For example, applying for a credit card is akin to applying for a loan. While your credit card statement will include a minimum payment amount, there’s no date set in advance for when that credit card debt has to be paid off.

With amortizing loans – like car loans and home loans – you’re expected to make payments on a regular basis according to something called an amortization schedule. Your lender determines in advance when your loan must be paid off, whether that’s in five years or 30 years.

The Interest on Your Car Loan

All About Auto Loan Amortization

Now let’s talk about interest. You’re not going to be able to borrow money to finance a car purchase without paying a fee (interest). But there’s a key difference between simple interest and compound interest.

When it comes to taking out a loan, simple interest is the amount of money that’s charged on top of your principal. Compound interest, however, accounts for the fee that accrues on top of your principal balance and on any unpaid interest.

Related Article: How to Make Your First Car Purchase Happen

As of April 2016, 60-month new car loans have rates that are just above 3%, on average. Rates for used cars with 36-month terms are closer to 4%.

The majority of car loans have simple interest rates. As a borrower, that’s good news. If your interest doesn’t compound, you won’t have to turn as much money over to your lender. And the sooner you pay off your car loan, the less interest you’ll pay overall. You can also speed up the process of eliminating your debt by making extra car payments (if that’s affordable) and refinancing to a shorter loan term.

Car Loan Amortization Schedules 

An amortization schedule is a table that specifies just how much of each loan payment will cover the interest owed and how much will cover the principal balance. If you agreed to pay back the money you borrowed to buy a car in five years, your auto loan amortization schedule will include all 60 payments that you’ll need to make. Beside each payment, you’ll likely see the total amount of paid interest and what’s left of your car loan’s principal balance.

While the ratio of what’s applied towards interest versus the principal will change as your final payment deadline draws nearer, your car payments will probably stay the same from month to month. To view your amortization schedule, you can use an online calculator that’ll do the math for you. But if you’re feeling ambitious, you can easily make an auto loan amortization schedule by creating an Excel spreadsheet.

To determine the percentage of your initial car payment that’ll pay for your interest, just multiply the principal balance by the periodic interest rate (your annual interest rate divided by 12). Then you’ll calculate what’s going toward the principal by subtracting the interest amount from the total payment amount.

For example, if you have a $25,000 five-year car loan with an annual interest rate of 3%, your first payment might be $449. Out of that payment, you’ll pay $62.50 in interest and reduce your principal balance by $386.50 ($449 – $62.50). Now you only have a remaining balance of $24,613.50 to pay off, and you can continue your calculations until you get to the point where you don’t owe your lender anything.

Related Article: The Best Cities for Electric Cars

Final Word

All About Auto Loan Amortization

Auto loan amortization isn’t nearly as complicated as it might sound. It requires car owners to make regular payments until their loans are paid off. Since lenders aren’t required to hand out auto amortization schedules, it might be a good idea to ask for one or use a calculator before taking out a loan. That way, you’ll know how your lender will break down your payments.

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