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Beware The Ball And Chain

. . . of a loan: avoiding prepayment penalties.
March 1, 2001
URL: http://www.entrepreneur.com/article/37564

Q: I've been approved for a loan to refinance my company's building. I called my lender for a final loan balance, and he reminded me that my loan had a prepayment penalty. After considering the rollover of the prepayment penalty into the new loan, the difference in terms and monthly payment was too close to bother refinancing. Can I do anything to have the prepayment forgiven or reduced?

A: It's likely too late in the game to negotiate. Forgiveness isn't a word I associate with banking, especially where prepayment penalties are concerned. By definition, a prepayment penalty is a fee a borrower agrees to pay if he or she pays the loan balance prior to its maturity date. It exists to protect the lender's profit margin.

There isn't any industry standard for prepayment penalties, but they usually run 3 percent of the loan's out-standing principal balance the first year on the books, 2 percent the second year and 1 percent the third year.

Historically, lenders have held grudges against borrowers wishing to pay their loans off early-and with good reason. A lending institution negotiates profitable terms on blocks of money they borrow and then extend to you. They know before they lend you the money the term extension that will maximize their profit, and a prepayment penalty ensures this profit isn't diminished if you interrupt that term by paying the loan off early.

Still, you don't get if you don't ask, so I suggest approaching your lender about forgetting the penalty anyway-just don't be surprised if the answer is no. A few of my clients' prepayment penalties have been waived, but it was mostly because they were financially strong as well as refinancing with the same institution, and the bank wanted to keep them happy to retain their business.

You've learned an expensive but valuable lesson in the world of business finance. To avoid another surprise like this down the road, be sure to tell your lender not to bring a prepayment penalty to the closing table.


Doug Hood is co-founder of Rainmaker Capital Corp., a capital acquisition consulting company in Cartersville, Georgia. Co-founder Marilea S. Hood contributed to this article. Send questions or anecdotes via e-mail to doughood@rainmakercapital.com.