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What is a Prepayment Penalty? What’s the Catch?

May 7, 2019

Imagine finally paying off your loan just to find out you owe the lender more money!  All because you’ve paid your debt off early. Instead of your lender rewarding you for paying the loan off earlier than your contract states, they charge you extra. Here’s what that is, how to avoid it, and what you can do.

 

What is a prepayment penalty?

 

A prepayment penalty is a fee charged to a borrower. If you pay off your loan earlier before the date planned in the contract the lender could charge you a prepayment penalty.

 

A prepayment penalty is charged once you’ve completed paying your debt, if it was paid it off early, or it could be a fee for overpaying the scheduled amount set per year. A prepayment penalty can be a fixed amount or based on what the remaining balance of your loan was set to be. For example, certain loans may allow you to pay off 20% extra each year before facing a fee.

What are prepayment penalties for?

 

When you borrow from an institution, they assume that it will take you a certain amount of time to repay the debt back, with interest. If you pay back your debt sooner, that institution may lose out on the interest that they collect. For this reason, loans like a mortgage might have a prepayment penalty to discourage people from refinancing or selling within the first few years.

 

You can think of a prepayment penalty as a way for the institution to ensure that it makes an adequate return amount for the credit they lent. Additionally, lenders charge prepayment penalties because if they place the loan in security and sell it, they need verification that the loan will be outstanding for a particular period of time. Having the security outstanding for a period of time will provide the buyer of the security a yield.

 

Student Loans

There are so many benefits to paying extra on your student loans each month. One of the main benefits – you’ll pay less interest over the life of the student loan. When it comes to student loans, you may be surprised to find out that there are no prepayment penalties. That’s right no prepayment penalties for both federal and private student loans. According to the Higher Education Opportunity Act of August 2008: “It shall be unlawful for any private educational lender to impose a fee or penalty on a borrower for early repayment or prepayment of any private education loan.”

 

Before you begin making extra payments towards your student loans, you should contact your servicer. Verify that the additional payment is being applied to the principal balance of the loan and not to the interest. If the overpayment is directed to the principal you’ll be able to pay down the debt faster.

 

Mortgage Loans

Mortgages don’t always have prepayment penalties, but some do. If there is a prepayment fee on your mortgage you should be able to review the details in the mortgage contract. It’s vital when signing a contract that you pay attention to the fine print. If you don’t understand something or need further clarity, be sure to ask questions.

 

When dealing with Mortgages, if you chose to refinance your loan there could be a prepayment penalty. Typically if you choose to refinance within the first three or five years of having the loan there may be a prepayment penalty fee that applies.  If you ever have any questions about prepayment fees you should contact your mortgage lender for clarity.

 

Auto Loans

When taking out an auto loan there are two types of interest that may be used in your contract, simple interest or pre-computed interest. Simple interest works similarly to a student loan, it is calculated based on the balance of the loan. Therefore, if you have an auto loan with simple interest, the sooner you can pay your loan off, the less interest you’ll pay.

 

The other type of interest is pre-computed interest. This interest is included in your agreement. It is a fixed amount calculated and added on at the beginning of the contract. Using a pre-computed interest rate is typically when you encounter prepayment penalties. Similar to mortgage loans it isn’t guaranteed that these loans have a prepayment penalty, but if so, it should be in the contract. Be sure to contact your lender or institution that services the loan to find out if there are any prepayment penalties before paying extra towards your debt.

 

Personal Loans

Personal loans can be used for a number of different reasons, from medical expenses to travel or even wedding expenses. When it comes to the prepayment penalty for personal loans, most companies will charge a percentage of the remaining balance. Though it’s likely your personal loan won’t have a prepayment penalty, you could still have one. Check with your lending institution or be sure to closely review your contract to see if there are any penalty fees for paying your debt down earlier.

 

 

Soft Penalty vs. Hard Penalty

 

You may have heard of two different types of prepayment penalties: soft and hard. A soft prepayment penalty would charge you a fee for refinancing, but not for other situations. A hard prepayment penalty would charge you for refinancing, prepayment, or selling (in the case of a mortgage – selling your house).

 

How can prepayment penalties affect you?

 

First, assuming you have multiple bills and debts that you pay each month, knowing whether any of them have a prepayment penalty can change how you pay. Imagine you have a student loan and a mortgage loan, you know the student loan doesn’t have any prepayment penalties, but the mortgage loan does. Let’s say that you’ve received some additional income and you want to put it towards one of the loans, but you aren’t sure which one. You’ll want to pay additional money toward the student loan debt because you won’t get penalized for paying it off early. Knowing a loan you’ve applied for has a prepayment penalty might motivate you to find a different borrower and give you the freedom to pay off that debt sooner without a fee.

 

Does this mean you should never pay off debts early? No way! There are plenty of loans and other types of debts that won’t have a prepayment penalty. The important thing is to know what you’re getting into. Read the fine print and ask questions during the application process. Also, for loans like a mortgage, there is typically a page you sign toward the end of the process that includes disclosures on things like whether there is a prepayment penalty, balloon payment, and so on. Always be aware of those disclosures before you take on new debt.

 

What is lifestyle creep? Is it affecting you?

 

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Young woman reading student loan news
2020-05-22
This Week in Student Loans: May 22

Please note: Education Loan Finance does not endorse or take positions on any political matters that are mentioned. Our weekly summary is for informational purposes only and is solely intended to bring relevant news to our readers.

  This week in student loans:
what you need to know about student loan debt relief

What you need to know about debt relief on student loans

As there have obviously been some major changes in the world of student loans recent, the Washington Post covers many frequently asked questions in this article, from the details of the Heroes Act to how the new changes affect a variety of borrowers.  

Source: Washington Post

 

college's loan default rate

Why a college's student loan default rate matters

With the extended deadline for "decision day" approaching, this US News & World Report brings to light how a college's default rate, or the average portion of students who default on their student loans, should matter to students who are choosing where to attend college.  

Source: US News & World Report

 

Donors provide students with debt relief

Anonymous donors paid off $8 million in student loans for first-generation grads

According to CBS News, a group of anonymous donors contributed a total of $8 million to pay off college loans for up to 400 first-generation college students who have overcome financial hardships, from homelessness to poverty. The donors are longtime supporters of Students Rising Above (SRA), a Bay Area nonprofit.  

Source: CBS News

 

Student Loan Debt Relief

More relief could be coming for student loan borrowers

While the CARES Act has already suspended federal student loan payments through September 30, 2020, a new bill known as the HEROES Act, passed by the House last Friday, would include additional relief for borrowers with both federal and private student loans, including potentially suspending federal student loans another year through September 30, 2021.  

Source: CNBC

    That wraps things up for this week! Follow us on FacebookInstagramTwitter, or LinkedIn for more news about student loans, refinancing, and achieving financial freedom.  
 

Notice About Third Party Websites: Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – the bank is not responsible for the content. Please contact us with any concerns or comments.

Clock representing the time it takes to pay off student loans.
2020-05-21
How Long Does it Take to Pay Off Student Loans?

If you have student loan debt, do you know what your loan term is and how long your payments are expected to last? On average, college graduates think they will have their loans paid off in six years. Is this a realistic expectation to pay off loans that quickly? Here we will show you how long it actually takes people to pay off student loans. And if you are looking for ways to pay them off faster, we have some tips for that as well.     

Loan Terms

The loan term is how long it will take you to repay the loan if you only pay the amount owed each month and do not make any additional payments. For federal student loans, the average loan term on the standard repayment plan is 10 years. However, there are options to increase the loan term up to 30 years, depending on the amount of money owed and what payment plan you choose. Increasing the loan term will cause you to pay more interest over the lifetime of the loan, but may require a smaller payment compared to the standard repayment plan.    

Average Time to Repay Undergraduate Loans

Although the standard loan term is ten years, many people take much longer than that to repay student loans. The average time it takes to repay student loans depends on what degree you obtained, mainly because of the amount of loans taken out. However, it also depends on the income you are earning. If you work in a job that is in your degree field, you may be earning the average income in the sector and be able to pay off your loans in the average amount of time. However, if you are not working in your degree field and your salary is lower than the average salary for that degree, it may take more time to pay off.
  • The average amount of student loan debt for a person who finished some college, but did not obtain a degree is $10,000. The average amount of time it takes to repay the loans is just over 17 years.  
  • For a person who obtained an Associate degree, the average amount of debt is $19,600 and on average it will take just over 18 years to pay off the loans. 
  • For college graduates that earned a Bachelor’s degree they will repay an average of $29,900 in student loan debt and will take approximately 19 years and 7 months to repay the loans. 
 

Average Time to Repay Graduate Loans

Earning a graduate degree takes more time and, of course, more money. The average amount of student loan debt for graduate degrees is $66,000. However, certain degrees require much more than the average amount of loans and, therefore, more time to pay. 
  • Medical school - The average student loan debt for medical graduates in 2019 was $223,700. Because of the high salaries doctors are able to earn after residency it can take an average of 13 years to repay the student loans. 
  • MBA - If you earn an MBA the average student loan debt is $52,600 and can take 22 years and 10 months to repay.
  • Law degree - Obtaining a J.D. may cause you to rack up the average of $134,600 in student loans and it will take an average of 18 years to repay.  
  • Dentist - To become a dentist it will cost an average of $285,184 in student loans and may take 20-25 years to pay off the debt.  
  • Veterinarians - Attending veterinary school can cost an average of $183,014 in student loans. It may take veterinarians longer to repay their student loans than traditional medical colleagues because their average income is much lower at $93,830. It can take 20-25 years to repay the loans. 
 

How to Pay Student Loans Off Early

If seeing these averages makes you panic, don’t worry! Use them as motivation to pay your loans off faster. Here are some ways to accomplish that:   

Student Loan Refinancing 

Refinancing student loans is extremely advantageous for many borrowers because it can save you money on monthly payments and in interest over the life of the loan. Refinancing can also be beneficial to shorten the length of time it takes to pay off your loans and save even more in interest costs. This can be done by obtaining a new loan with a shorter term than your current remaining loan length. Although refinancing to a shorter term length will increase your monthly payment, if you are able to afford the new payment it can be a great financial move for your future. You will be paying your loans off sooner and saving more in interest.     For example:  If you have $30,000 in student loans with a standard 10 year repayment plan and 7% interest rate, your payment would be $348 per month. If you refinance to a 7 year loan and qualify for a 6.48% interest rate, your payment would only increase by $62.00 per month and your loans would be paid off 3 years earlier. You would also save $4,403 in interest!   If you did not want to increase your monthly payment you could still utilize the benefits of refinancing by keeping the same loan term and qualifying for a lower interest rate than your current rate. With the same example as above, if you refinance to a 10 year term loan with a lower interest rate it would still save you $573.00 in interest. Qualifying for an even lower interest rate could save you up to $5,590 in interest.     To see your potential savings, use our student loan refinancing calculator.*   

Make Extra Payments 

No matter what payment plan you have for your student loans, making extra payments can be a beneficial way to shorten the amount of time it takes to pay off your loans, including saving you in interest costs.    

Conclusion

Tackling student loan debt may seem daunting at times, but payments don’t last forever. If it’s your goal to pay your loans off as quickly as possible, hopefully using some of these tips will help you reach that goal. Knowing the average time it takes to pay off loans will allow you to set realistic expectations for your financial goals.   
  *Subject to credit approval. Terms and conditions apply.   Notice About Third Party Websites: Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – the bank is not responsible for the content. Please contact us with any concerns or comments.
Chart of rates over time
2020-05-18
Current LIBOR Rate Update: May 2020

This blog provides the most current LIBOR rate data as of May 7, 2020, along with a brief overview of the meaning of LIBOR and how it applies to variable-rate student loans. For more information on how LIBOR affects variable rate loans, read our blog, LIBOR: What It Means for Student Loans.

 

What is LIBOR?

The London Interbank Offered Rate (LIBOR) is a money market interest rate that is considered to be the standard in the interbank Eurodollar market. In short, it is the rate at which international banks are willing to offer Eurodollar deposits to one another. Many variable rate loans and lines of credit, such as mortgages, credit cards, and student loans, base their interest rates on the LIBOR rate.

 

How LIBOR Affects Variable Rate Student Loans

If you have variable-rate student loans, changes to the LIBOR impact the interest rate you’ll pay on the loan throughout your repayment. Private student loans, including refinanced student loans, have interest rates that are tied to an index, such as LIBOR. But that’s not the rate you’ll pay. The lender also adds a margin that is based on your credit – the better your credit, the lower the margin. By adding the LIBOR rate to the margin along with any other fees or charges that may be included, you can determine your annual percentage rate (APR), which is the full cost a lender charges you per year for funds expressed as a percentage. Your APR is the actual amount you pay.

 

LIBOR Maturities

There are seven different maturities for LIBOR, including overnight, one week, one month, two months, three months, six months, and twelve months. The most commonly quoted rate is the three-month U.S. dollar rate. Some student loan companies, including ELFI, adjust their interest rates every quarter based on the three-month LIBOR rate.

 

Current 1 Month LIBOR Rate - May 2020

As of May 7, 2020, the 1 month LIBOR rate is 0.20%. If the lender sets their margin at 3%, your new rate would be 3.20% (0.20% + 3.00%=3.20%). The chart below displays fluctuations in the 1 month LIBOR rate over time.

 

(Source: macrotrends.net)

   

Current 3 Month LIBOR Rate - May 2020

As of May 7, 2020, the 3 month LIBOR rate is 0.43%. If the lender sets their margin at 3%, your new rate would be 3.43% (0.43% + 3.00%=3.43%). The chart below displays fluctuations in the 3 month LIBOR rate over time.

  Chart of 3 Month LIBOR for May 2020 (Source: macrotrends.net)  

Current 6 Month LIBOR Rate - May 2020

As of May 7, 2020, the 6 month LIBOR rate is 0.69%. If the lender sets their margin at 3%, your new rate would be 3.69% (0.69% + 3.00%=3.69%). The chart below displays fluctuations in the 6 month LIBOR rate over time.

  Chart of 6 Month LIBOR May 2020 (Source: macrotrends.net)  

Current 1 Year LIBOR Rate - May 2020

As of May 7, 2020, the 1 year LIBOR rate is 0.78%. If the lender sets their margin at 3%, your new rate would be 3.78% (0.78% + 3.00%=3.78%). The chart below displays fluctuations in the 1 year LIBOR rate over time.

  Chart of 1 Year LIBOR May 2020 (Source: macrotrends.net)  

Understanding LIBOR

If you are planning to refinance your student loans or take out a personal loan or line of credit, understanding how the LIBOR rate works can help you choose between a fixed or variable-rate loan. Keep in mind that ELFI has some of the lowest student loan refinancing rates available, and you can prequalify in minutes without affecting your credit score.* Keep up with the ELFI blog for monthly updates on the current 1 month, 3 month, 6 month, and 1 year LIBOR rate data.

 
 

*Subject to credit approval. Terms and conditions apply.

 

Notice About Third Party Websites: Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – the bank is not responsible for the content. Please contact us with any concerns or comments.