Glossary
Prepayment penalty
A fee for repaying a loan early. It exists because the lender priced the loan expecting a stream of interest, and it can make a refinance that looks worthwhile on rate alone not worth doing.
Prepayment penalty: A fee for repaying a loan early. It exists because the lender priced the loan expecting a stream of interest, and it can make a refinance that looks worthwhile on rate alone not worth doing.
Why it matters
A prepayment penalty is a constraint on your future options. It affects whether you can refinance into a better rate, whether you can sell the business cleanly, and whether a windfall is best used to clear debt.
The penalty is frequently the difference between a refinance saving money and costing it, and borrowers often discover it only when they request a payoff figure.
The common structures
| Structure | How it works |
|---|---|
| Step-down | A percentage of the balance that declines over time — for example 5% in year one, 3% in year two, 1% in year three, then nothing. |
| Fixed percentage | A flat percentage of the amount prepaid, for the whole term. |
| Yield maintenance | You compensate the lender for the interest it expected to earn. Can be very large, and common in commercial real estate. |
| Lockout | Not a fee at all — you simply may not prepay for a defined period. |
| None | Many SBA 7(a) loans with shorter maturities, and most online term loans. |
The SBA position
SBA 7(a) loans with longer maturities carry a declining prepayment fee in the early years, applying where you repay a substantial share of the balance in a single year. Shorter 7(a) loans typically have none. 504 loans have their own declining schedule tied to the debenture structure.
This is one of the quieter advantages of SBA borrowing, and it is worth confirming against your own note rather than assuming.
Before you refinance
- Request a written payoff figure that includes the penalty.
- Add the penalty to the new loan's closing costs.
- Work out the monthly saving from the new rate.
- Divide total cost by monthly saving: that is your break-even in months.
- If you might sell or refinance again before break-even, the refinance loses money.