What is a prepayment penalty?

A prepayment penalty is a fee charged by a lender to the borrower when the borrower pays off the loan early.

Not all lenders charge prepayment fees and even those that do often have a certain time period when the prepayment penalty will apply. That is, with some loans a prepayment penalty will only be in effect for a specified period of time, such as two years.

For example, an lender may charge a prepayment penalty if the auto loan is paid in full within the first two years of the loan. In this example, a borrower paying off the loan before two years would be charged a prepayment penalty but that same borrower paying off the loan after the initial two-year period would not be charged this type of fee.

Be sure to inquire about any prepayment penalties that may apply to your next auto loan before signing on the dotted line.