How to Avoid Prepayment Penalties

Posted by Mrs Money on March 24th, 2009

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A few weeks ago, my friend Kacie was talking about how she’s changing up her plans on paying her car loan off early.  She was saying that she’d have to pay a 1% “prepayment penalty” for paying off the loan early.  I was so excited when I realized I could help her save that money instead of paying it. I hate that banks charge clients for paying off loans early.  That just seems so backwards to me.  Every time I get to the prepayment penalty line during a loan closing, I explain to my clients how they can get around the prepayment penalty.

Here’s how you can do it.  Say you’ve got enough money saved to pay off your loan in full.  The bank you’re using charges a 1% prepayment penalty.  Your remaining balance is $10,000.  If you go to the bank and ask for a payoff amount, they are going to tell you somewhere in the ballpark of $10,100.  ($10,000 principal balance plus 1% prepayment penalty)  It will probably be a little more because of unpaid interest that hasn’t been billed yet.  Instead of making a lump sum payoff, break it down.

Ask to make a principal only payment of $9,999 or something close to that amount.  Make sure you find out how long it takes for the payment to post.  At my bank it’s usually overnight.  The next day, go in and ask for a payoff calculation.  Your new balance is going to be around $1 plus any unpaid interest.  When the teller gives you a payoff, the prepayment penalty is going to be a penny!  (1% of $1)  Awesome!  Make sure you share with your financial savvy friends!    

And that’s how you avoid a prepayment penalty!  I hope I’ve explained that well enough.  Please let me know if something’s not clear.

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21 Responses to “How to Avoid Prepayment Penalties”


  1. Deirdre says:

    That’s a great idea, however, I can’t see why anyone would take out a loan with a prepayment penalty in the first place. There are always options to doing that…

    [Reply]

  2. Miss M says:

    Interesting, I never would have thought of it. I didn’t know car loans sometimes came with a prepayment penalty, I know they are common with mortgages. I paid my car off early and fortunately there was no penalty.

    [Reply]

  3. rosemarie says:

    I have never seen a loan with a prepayment penalty (but it’s been a long time since I’ve had a car loan ). But this is a great thing to look out for – A) maybe I can make negotiate not to have it or B) know what to do just in case.

    Thanks again!

    [Reply]

  4. Slinky says:

    Apparently it’s illegal in my state to have a prepayment penalty on a car loan. Can’t argue with that!

    [Reply]

  5. Mrs Money says:

    Deirdre- That’s totally true! Unfortunately, at my bank there are no loans without prepayment penalties. It’s crazy!

    Miss M- I am glad you didn’t have one!!

    rosemarie- I make sure that my customers are fully aware of it and how they can get around it before they sign the loan docs. I’d feel so bad if I didn’t explain it!

    Slinky- That’s awesome! I personally think it’s silly for banks to charge people for being good customers and paying it off early, but of course the bank looks at it that they are losing that extra interest.

    [Reply]

  6. Harrison says:

    Hey, what a nice idea to save up the money. I think banks are too business minded and always think some ways to charge us. Lucky we have a creative people like you to help us overcome this prepayment penalty. I will use this next time I want to pay off my mortgage.

    Last but not least, thanks for the idea. I really appreciate it. :)

    [Reply]

  7. Mrs Money says:

    Harrison- Thank you so much for your lovely comment! My mortgage doesn’t have a prepayment penalty so you may want to check with yours as well. Thanks again! :)

    [Reply]

  8. Sanjay says:

    Can you guys believe it’s as high as 5% in India. No partial repayments allowed so your idea won’t work :( tsk tsk (I mean on car loans).

    Have posted a blog on mine. Do let me know your views on that.

    Cheers!

    [Reply]

    Mrs Money Reply:

    Wow, that sucks! I don’t think it’s fair that they charged you after you were not an employee any more. At the bank I work at, once you have signed the contract, the terms don’t change. For instance, I got a .25% discount for using automatic payments. I stopped that, but my rate didn’t go up. Crazy!

    [Reply]

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    [Reply]

  10. Patrick says:

    I have a mortgage with ING and in Feb I modified it with proviso that if I paid off mortage inside of a year, would be subject to 1% penalty on amt of mortage. Having just sold my home, I had no choice and stand to lose $22k. Any suggestions out there? I live in NJ where it is not permitted to charge penalty for early pay-off, however, ING is based in MN. Thanks!

    [Reply]

    Mrs Money Reply:

    Patrick- I would call ING and ask them. Is your mortgage $220,000? That would be a $2,200 penalty. Hopefully that’s the case and you don’t lose $22K. That would suck! You would think that because you’re selling the house you would be exempt, but I’m not sure if that matters or not. I’d call ING and ask to be sure! :)

    [Reply]

    Patrick Reply:

    Thanks so much – you were SO RIGHT! They previously told me over the phone the penalty was 1%, however when I called back they told me my modification agreement was penalty of 3% or $22k. They explained that shortlty after my modification, they lowered the penalty to 1%. I pleaded with a manager and explaiend that it took me over 2 years to sell my home and that I never modified my mortage while house was for sale (not allowed) and was never late on a payment. They agreed to honor the 1% penalty rate and will be refunding me $15k within the next 2wks. In addition, should I originiate a new mortgage with ING within 6mths, they will apply my penalty amt ($7600)to the closing costs, and refund the remainder to me. VERY good news and thanks so much for your thoughts! Patrick

    [Reply]

    Mrs Money Reply:

    Patrick- That’s awesome!! I hope that everything works out for you. Thanks so much for letting me know I could help!
    xoxo,
    MM


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