Can You Pay the Loan Off Early Without a Charge?

What counts as a prepayment penalty

The plain version is a flat fee or a percentage of the balance charged when you pay off early. Regulation Z treats other charges the same way. Its official commentary lists, among others, interest charged as if the balance were still owed for a period after you paid it off, a minimum finance charge on a simple-interest loan, and a fee the lender waived at the start on the condition that you would not prepay, then collects when you do.

An origination fee taken out of the loan is not a prepayment penalty, but it is not refunded either. If you pay off a loan with a 5% fee after a few months, the fee has already done its work on your cost. See net loan proceeds for how that fee is counted.

Simple-interest and precomputed loans

The agreement usually tells you which kind you have. Look for words such as "simple interest" or "interest accrues daily" on one side, and "precomputed", "add-on interest" or a section on rebates of unearned finance charges on the other. If the agreement does not say, ask the lender before you sign.

The Rule of 78s: a worked example

The Rule of 78s is a rebate method that books more of the interest in the early months. For a 36-month loan, it adds the month numbers 1 through 36 (the sum is 666) and assigns the first month 36/666 of the interest, the second 35/666, and so on. The actuarial method instead charges interest only on the balance actually owed each month.

Take the site-wide example: $10,000 at 14% for 36 months, a payment of $341.78 and $2,304.08 of interest over the full term. Suppose you pay it off right after the 12th payment. The figures below are computed examples, not offers.

On this loan the Rule of 78s costs you $46.45 more than the actuarial method. The gap grows with a higher rate or a longer term, and it is widest when you pay off early in the loan. Use the extra payment calculator to see what an early payoff saves on a simple-interest loan.

What federal and state law say

• Disclosure. Regulation Z, 12 CFR 1026.18(k), requires a definite statement of whether a charge may be imposed for paying all or part of the principal early, and, on a precomputed loan, whether you are entitled to a rebate. Silence does not count as "no penalty".
• Refund of unearned interest. Under 15 U.S.C. 1615, when you prepay in full the lender must promptly refund unearned interest (refunds under $1 are excused). The same section bars the Rule of 78s on precomputed consumer credit with a term over 61 months consummated after September 30, 1993; the refund must equal or beat what the actuarial method would give you.
• Payoff statement. On a precomputed loan, the lender must give you the payoff amount within 5 days of your request, free once a year.
• Servicemembers. The Military Lending Act (32 CFR 232.8) forbids a prepayment penalty, or a ban on prepaying, for covered borrowers.
• States. Many state lending laws set their own limits on prepayment charges and rebate methods. Check the rules for your state in State rules.

How to find it on your offer

1. 1 Open the Truth in Lending box and find the prepayment line. It should say either that you may have to pay a penalty or that you will not. See the federal disclosure box for the other lines.
2. 2 Check the refund wording. The box may also say whether you get back part of the finance charge. On a precomputed loan that line is the rebate; on a simple-interest loan with a fee it usually means the fee stays with the lender.
3. 3 Read the matching clause in the agreement for the amount of any penalty, and the refund method on a precomputed loan.
4. 4 Ask the lender in writing how an early payoff is calculated, and keep the answer with your loan papers.

Questions people ask