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Prepayment Penalties: When the Faraway Bird Does Not Get the Worm

This is the dream of every small business owner: you have taken out a business loan to start or expand your small business, and it has really paid off. Business is booming, cash flows and you suddenly find yourself in the coveted position of being able to repay your loan well before you anticipated.

While you've always wanted to fill your tub with bills and jump in, you know the best choice would be to pay off this pesky loan once and for all.

Because the primitive bird receives the worm, is not it?

You might be shocked to hear that, but not always. Before you rush to your lender with a check in hand, slow down. Beyond the reasons why early repayment of your loan may not be the best use of your extra income, you could actually pay a penalty to pay off your loan before the scheduled date in your policy.

What is a prepayment penalty?

Although many factors come into play in determining what is considered a true prepayment penalty, the term is more easily defined as a clause in your loan agreement stating that a penalty will be imposed if your loan is refunded or refunded. period of time.

Being penalized for paying off your loan balance may seem like a punishment. We all know the late fees, but the initial fees? Really? It seems just enough back to ask you …

But do not lenders want their money sooner?

One would think that most lenders would be happy to repay you their money earlier, but this is usually not the case. As with any for-profit business, the goal of business lenders is to make a profit from your borrowing money.

This profit is made in the interest that a lender bills you while you borrow his money. If you surrender this money sooner than expected, the lender will lose the interest that he expected to charge you for the full term of the loan. The solution to this is the prepayment penalty – it exists to make sure that the lender will make a profit if you pay their interest on their money for the duration of the loan, or if you pay it early.

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Although many lenders and loan products do not have prepayment penalties, if you have taken steps to pay off your commercial loan and discovered that your loan is subject to a prepayment penalty, you will need to and crunchy calculator to arrive at the best choice for you.

Weighing Your Options

When attempting to make a decision about prepaying your loan, it is helpful to first understand the terms of your loan. There are several types of business loans that may have prepayment penalties.

  • The Traditional Term Loan : This type of loan is most likely to have a prepayment penalty. That's because they usually come with fixed interest rates and fixed monthly payments, and generally have the longest repayment terms around. If you repay this loan in advance, the lender would lose a fairly high amount of interest, so that a prepayment penalty is applied to secure his profit.
  • SBA Loan : While almost all loans from the Small Business Administration's loan program do not include prepayment penalties, there is one exception: a loan of a duration 15 years old. This follows from the fact that this early repayment would result in a substantial reduction in the lender's interest.
  • Short Term Loan : Although this type of loan probably has no monetary penalty, the lender can recover its loss of interest in case of prepayment by increasing the Annual percentage rate (APR) of your loan, which is the interest rate of the loan plus any additional charges.

After identifying the type of loan you have, the next most important step is obviously to determine what type of prepayment penalty is attached to your loan.

  • Flat Rate : This type of prepayment penalty is easy to understand – the lender calculates a commission related to your loan terms and asks you to pay a lump sum in case of payment anticipated your loan.
  • Penalty Pure and Simple : This is a clause that costs you a certain percentage of your remaining interest, regardless of other factors.
  • Penalty on the sliding scale : this penalty is what it gives: the sooner you pay your loan, the greater the penalty.
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Other factors

Although the final figures are certainly important in deciding whether it is worthwhile to repay your loan in advance, there are other factors to consider. Let's take a look at the biggest advantages and disadvantages of paying off your loan earlier:


  • No More Debt : If the emotional factor plays a big role in your life and you are tired of your loan that weighs on you, it may be worth the early repayment for you to live without debt. It's a personal choice that only you can do!
  • Make hay while the sun is shining : As small business owners know, business can be a feast or a famine. If you experience a sudden influx of cash, it is justified to want to repay your loan while you are in the "party" part of the cycle.
  • High interest rate : run the numbers and see. If your loan comes with high interest rates, it can save you money in the long run, despite the penalty for early repayment.


  • Cash Flow : While repaying your loan would seem good to you, you must be wondering if this is the best use of your extra money. Dig deep and determine if your business can really withstand a cash shortage by paying off your loan, or it would be wiser to invest in new equipment, inventory or marketing. And it's always a wise decision to create a fund for unforeseen expenses.
  • Taxes : Interest on your business loan payments is tax deductible, but if you repay the loan sooner, you will show more profits and have to pay taxes higher.
  • Company credit score : If your lender is not satisfied with your prepayment, it may declare your loan in whole, but unsatisfactory, which will reduce your credit score. corporate credit. Before making the decision to repay your loan sooner, be sure to discuss it with your lender.
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The takeaway

Only you can decide whether to repay your loan sooner and potentially face a prepayment penalty is good for you and your small business. The key to letting the open payment option open to your business is to read the fine print of your loan before entering into an agreement. Ask your lender about their policies on prepayment penalties before you take out a loan, and you will set up your small business for the greatest flexibility in the future.