Why Do Prepayment penalties on loans exist?

  • Updated on: 12 Oct 2023
  • Published on: 6 Oct 2020
Why Do Prepayment penalties on loans exist?

The personal loan preclosure charges are among the charges you will likely pay when repaying your loan. However, it is a conditional charge, levied only if you decide to prepay your loan.  

That said, most borrowers availing these unsecured forms of credit may be unaware of the charges they have to incur during the prepayment of loans. That’s precisely why checking the additional charges levied by a lender before finalising a specific loan offer is important. 

Read on to learn more about prepayment penalty charges and how to avoid them.

What is a prepayment penalty?

A lender levies a prepayment penalty, amounting to a certain percentage of the outstanding balance when a borrower pays off the loan entirely or partially before the term. The lender must disclose the prepayment charges on personal loans before sanctioning a new loan. 

This helps ensure that the borrower is well informed of the consequences that may entail while prepaying the loan before the end of the term. 

How does a prepayment penalty Work?

Personal loan preclosure charges are levied to help compensate for the cost of lost income by the lender. Given a choice, a lender would rather lend to a borrower who pays precisely on time – not prior or later – to generate maximum income from the interest. This is why prepayment penalties have traditionally been put in place.

These penalties don’t just come into play when the borrower pays off the entire loan. Still, some of these also apply if you pay a considerable part of the loan as a single payment. Also, lenders can recover profits using prepayment penalties when offering loans at below-average interest charges.

On prepayment of a personal loan, lenders may calculate the penalty based on the remaining principal or how much interest remains once you’ve paid off the loan. The fee can also be a fixed amount decided before signing the loan agreement.

Also Read: Personal Loan Foreclosure Charges

How to calculate prepayment penalties?

As mentioned earlier, lenders calculate prepayment penalties in various ways. This mainly depends on the kind of loan you have taken – a small personal loan, a substantial loan – or how the lender calculates it. 

You must know how to calculate the penalties beforehand to determine if prepaying the loan is beneficial. The various ways to calculate it are as follows:

  • Interest costs: In this case, the lender applies the prepayment penalty on the total interest paid by the borrower by the end of the term.
  • Percentage of balance: Sometimes, a certain percentage of the amount pending on the loan is taken as the penalty fee. 
  • Flat fee: Some lenders have a fixed prepayment penalty that the borrowers must pay regardless of how early they pay the loan. 

How to avoid the prepayment penalty?

The best way to avoid a prepayment penalty is to find a lender who doesn’t charge a prepayment fee on loans. Make sure to ask relevant questions like if it is for a certain number of years or the entire term of the loan. 

Besides this, there are other ways to prevent a prepayment penalty. 

  • One can always talk to the lender about the prepayment of a personal loan and you may be able to do it close to the final due date and skip the penalty that way. 
  • You can check the paperwork to see if there’s a possibility of paying a partial amount of the loan without penalty. This way, you can pay off the debt earlier without any penalty. 
  • Perhaps the most crucial aspect to remember is that online platforms like Fibe provide loans without prepayment penalties. This is one of the smarter ways to avail a loan without incurring additional costs.

The dos and don’ts of prepayment penalty clause on loans


  • Accustom yourself to the policies of the lender. It can help you find banks that don’t charge any penalty. For example, the RBI has asked banks not to impose any prepayment penalties on floating rate home loans. 
  • Read all the points on the prepayment penalty clause and know its exact terms. Also, check if these policies are valid only before or after a certain number of years.
  • Trust brands like Fibe that reward financial discipline by not levying any prepayment penalties on any of their loans. 


  • If you already have a loan with a prepayment penalty, do not just pay it off or try to refinance it without correctly assessing your outgo. 
  • The best thing to do is not to accept any loan with a penalty clause. 

Get an Instant Personal Loan from Fibe to ease the burden of loan repayment and prepay without paying any additional fees. Feel free to contact us for any questions on credit, loans and your instant cash needs! Download the Personal Loan App here, or log in to our website and register to get started!

FAQs on Personal Loan Preclosure Charges

Is there any penalty for the prepayment of a personal loan?

While some lenders levy personal loan preclosure charges, others don’t have any prepayment penalty clause in their loan contracts. Lenders must inform about prepayment penalty charges even before the loan agreement is finalised.

How can I avoid a prepayment penalty on my loan?

To avoid prepayment charges on personal loans, you can talk to the lender to skip the penalty close to the final due date. Revisit your loan agreement to check if you can make a partial payment without incurring any penalty. Moreover, you can avail of an instant personal loan on online platforms like Fibe that do not charge a penalty on its prepayment.

Is it good to close a personal loan early?

It may be beneficial to prepay a loan if the lender does not charge any penalty, as you can save on the interest payable. 

Does prepayment affect the CIBIL score?

No, loan prepayment does not affect the CIBIL score in any way.

Will prepayment reduce the interest?

Prepaying a loan reduces the total outstanding amount. In turn, the EMIs due on loan repayment, as well as the interest component, are reduced.


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