While not particularly intuitive to the layman borrower, prepayment penalties seek to prevent you from clearing your debt early. Many of us figure that our creditors would be happy to receive our money earlier, but this is not the case due to a decrease in interest payment owed. By inserting such penalties, creditors are assured that the predicted profit received from initially extending the loan, is protected. To put it more explicitly, the shorter the term of your loan, the less interest you owe, and thus the less profit made by the creditor on your loan.
How do prepayment penalties apply?
Often termed as a prepayment disclosure in loan agreements, the prepayment penalty is imposed on a borrower when they pay off amounts due before the loan’s term. Effectively they may emerge when you try one of the following three actions:
– Attempting to increase the amount paid at each interval
– Refinancing the loan
– In the event of a mortgage (secured loan), you sell the collateral away
Typically, lenders allow borrowers to pay up to 20% of their remaining loan balances without triggering the penalty. However, this differs based on the loan agreement signed.
How steep are prepayment penalties?
There are two types of prepayment penalties, fixed and sliding scale. The more commonly used of the two, the sliding scale penalty is based on the remaining amount left in your loan. The less money you owe, the smaller the penalty will be as the lender has already made back some profit on the loan. On the other hand, fixed penalties involve a single fixed fee for each time the agreement is breached.
What can you do if your loan already has prepayment penalties?
If you are reading this article and are uncertain whether your loan agreement has prepayment penalties, and how they may affect your repayment flexibility, then read our simple 4 step guide.
Step 1: Read your fine print to find terms similar to ‘prepayment disclosure’
Step 2: Determine if the nature of the penalty is fixed or sliding scale
Step 3: Workout the math to determine if incurring the penalty is beneficial when taking into account the reduced interest paid
Step 4: Talk to your loan officer to negotiate for a less steep penalty or possibly even a waiver
When should you agree to have prepayment penalties in your loan agreement?
If you are shopping around for a preferable personal loan in Singapore, then you may be tempted to strictly rule out any offers that include pre-payment penalties. While it is obviously in your best interest to avoid it, prepayment penalties are often included to balance out other desirable elements in the contract. In a way, it can be thought of as an exchange of flexibility for favorable terms.
It should also be pointed out that you should only seek personal loans from a licensed money lender. In Singapore, all licensed money lenders are governed by the Registry of Moneylenders, which seeks to protect borrowers from unfair practices or loan terms. As such, they can be trusted to be transparent about prepayment penalties in your loan agreement, and help you to make an informed decision.