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Prepayment penalty
Also called early termination fee, prepayment charge, exit fee, prepay.
A charge for repaying early - a flat fee, a stepped percentage, a lockout or a yield-maintenance calculation - and on advances, a cost imposed instead by the absence of any early payoff discount.
Drafted with AI assistance and checked by a person. Its factual claims were verified against the sources listed at the end, by Find Me Funders research desk.
What it means
## On loans
The provision takes several forms. A flat fee. A stepped percentage of the balance that declines over time, quoted as something like 3-2-1 for the first three years. A lockout period during which prepayment is simply not permitted. Or yield maintenance, which calculates what the lender loses in interest and charges that, and which can be substantial on a long fixed-rate facility in a falling-rate environment.
SBA 7(a) loans with longer maturities carry a prepayment charge in the early years under program rules, and the SBA publishes the current terms. Equipment finance agreements frequently state a payoff as the remaining payments less an unearned-charge credit, which is a prepayment formula whether or not it is labelled a penalty.
## On advances
Factor-rate cost does not accrue. The purchased amount is fixed at signing, so retiring it in month two rather than month eight does not reduce it unless the agreement contains an explicit early payoff discount. There is no penalty clause because none is needed - the whole amount is simply owed.
Some funders publish discount schedules, and many will negotiate a payoff at renewal time when they want to write the next deal. That is a commercial concession, not a right, unless it appears in the document you signed.
Where this one catches people
'No prepayment penalty' on an advance is marketed as a benefit and is usually the reverse. On an amortising loan, paying early saves the unaccrued interest. On a factor-rate advance with no discount clause, paying early saves nothing and raises your effective annualised cost, because the same fixed dollar cost was compressed into fewer days. The absence of a penalty is not the presence of a discount.
Worked through
Illustration, loan. $200,000 at 9% over five years, repaid at month 18 with a 2% prepayment charge. The payment is about $4,152 a month and roughly $149,100 remains at month 18. The charge is about $2,980 — but the interest avoided over the remaining 42 months is about $25,300, so prepaying still wins on total dollars.
Illustration, advance. $91,000 purchased amount on a $70,000 purchase price, collected at about $619 a banking day and repaid in full at month three instead of month seven. The payoff is $91,000 either way. Nothing is saved; the $21,000 cost has simply been paid over three months rather than seven. On those cash flows the annualised cost rises from roughly 94% if the deal runs to term to roughly 136% if it is retired at month three — about half as much again, not double, because most of the money was still outstanding when the balloon was paid.
Figures in the example are illustrative. They show the arithmetic, not a quote — what any one lender would charge is on that lender's page, where it is published at all.
Where you will meet this term
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Sources and checks
Every figure on this page traces to a document someone read, on a date. Where a check is past its review date it says so rather than passing as current.
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CORRECTED: the balance on a $200,000 9% five-year loan at month 18 is $149,102, not 'roughly $152,000', so the 2% charge is $2,982, not 'about $3,040'
examplei = 0.09/12 = 0.0075, n = 60. PMT = 200,000 x 0.0075 / (1 - 1.0075^-60) = 4,151.67. Balance after 18 payments = 149,101.92 (the entry overstated it by about $2,900). 2% x 149,101.92 = 2,982.04. Sum of the remaining 42 payments = 174,370.18, so interest avoided = 174,370.18 - 149,101.92 = 25,268.26 — the entry's conclusion that prepaying still wins is confirmed, the figures were not.
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CORRECTED: retiring a $91,000 / $70,000 advance at month three instead of month seven does not roughly double the annualised cost; it raises it by about 45%
example91,000 / 70,000 = 1.30 factor, $21,000 cost. Over seven months at 21 banking days a month, 91,000 / 147 = $619.05 a day; IRR of [-70,000; 147 x 619.05] = 0.3720% per banking day, x 252 = 93.74% nominal annual. Payoff at month three: 63 x 619.05 = 39,000 delivered, $52,000 balloon on day 63; IRR = 0.5407% per day, x 252 = 136.25%. 136.25 / 93.74 = 1.45. The entry applied the naive term ratio (7/3 = 2.3) to a balloon payoff, which the entry's own text elsewhere warns against; the annualised figure was also asserted without fixing a collection schedule, so the daily amount has been supplied.
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SBA 7(a) loans with maturities of 15 years or more carry a subsidy recoupment fee in the first three years, so the entry's 'longer maturities carry a prepayment charge in the early years' is accurate
definition13 CFR 120.223: the fee applies where the loan 'has a maturity of 15 years or more' and the borrower voluntarily prepays 'more than 25 percent of the highest outstanding principal balance' in one of the first three 12-month periods after initial disbursement, at 5% of the prepayment in year one, 3% in year two and 1% in year three.
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SBA publishes the current prepayment terms for 7(a) loans, as the entry states
definitionSBA, Terms, conditions, and eligibility (7(a) loan program): 'For loans with a maturity of 15 years or longer, prepayment penalties apply when the borrower voluntarily prepays 25% or more of the outstanding balance of the loan' within the first three years — 'During the first year after disbursement, 5% of the amount of the prepayment. During the second year after disbursement, 3%... During the third year after disbursement, 1%...'
Prepayment penalty — common questions
What does prepayment penalty mean?
A charge for repaying early - a flat fee, a stepped percentage, a lockout or a yield-maintenance calculation - and on advances, a cost imposed instead by the absence of any early payoff discount.
Where does prepayment penalty catch people out?
'No prepayment penalty' on an advance is marketed as a benefit and is usually the reverse. On an amortising loan, paying early saves the unaccrued interest. On a factor-rate advance with no discount clause, paying early saves nothing and raises your effective annualised cost, because the same fixed dollar cost was compressed into fewer days. The absence of a penalty is not the presence of a discount.
Is prepayment penalty the same as an interest rate?
Prepayment penalty is defined above; if you are comparing it against a rate, check whether the two measures share a time dimension before you put them side by side.
Which products does prepayment penalty apply to?
Merchant Cash Advance, Term Loan, Business Line of Credit, SBA Loan, Equipment Financing.
Is there a worked example of prepayment penalty?
Yes, on this page, and it is labelled illustrative. It shows the arithmetic, not a quote from any lender.
What else should I read alongside prepayment penalty?
Annual percentage rate, Factor rate, Payoff quote, Prime rate, Purchased amount.
Has this definition been checked?
Yes. Its claims were verified against the sources listed at the end of this page, and the reviewer is named.
Is this legal advice?
No. It is a definition. What a clause does in your contract, in your state, is a question for a lawyer licensed where you are.
Can I suggest a term?
Yes — [email protected]. The glossary grows from what people are actually shown in contracts.