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I haven't seen this in some years, but I assume prepayment penalties still exist.
Okay, I get the part about charging higher interest rates to those considered a high(er) risk. Fair enough.
If a person is such a high risk, one might expect a lender to be happy - even thrilled - when that high-risk borrower pays early. Wouldn't it be a reiief to get back with interest your money early, so that you could re-lend it to a more qualified borrower?
And when a lender drastically overestimates a borrower's risk, instead of the lender facepalm one might expect, the borrower gets to pay a huge prepayment penalty.
most loans are packaged and sold off to investors so new loans can be made. investors who buy these packages expect a certain return and that is why they buy them as well as the banks have costs and people to pay for selling those loans to investors . if the loans are not sold then the banks themselves need to earn x amount to keep the lights on with each loan.
not every dollar that comes back gets reloaned instantly either. that money you payed back wearly may get nothing on it until the next borrower shows up.
very few loans today have them and banks charge you elsewhere for everything they used to do free
I haven't seen this in some years, but I assume prepayment penalties still exist.
Okay, I get the part about charging higher interest rates to those considered a high(er) risk. Fair enough.
If a person is such a high risk, one might expect a lender to be happy - even thrilled - when that high-risk borrower pays early. Wouldn't it be a reiief to get back with interest your money early, so that you could re-lend it to a more qualified borrower?
And when a lender drastically overestimates a borrower's risk, instead of the lender facepalm one might expect, the borrower gets to pay a huge prepayment penalty.
The thing is, there are two separate risks here for the lender: Default risk (credit risk) and reinvestment risk.
The default risk has already been accounted for by the interest rate specified in the original contract. It is supposed to be that the interest rate should make the lender economically indifferent to early principal repayment or not, by being adjusted to compensate for the default risk (credit risk).
But this ignores reinvestment risk for the lender. If the borrower chooses to prepay the debt, the lender may not be able to re-invest with the corresponding terms, since the LIBOR or fed funds rate may be lower at that point in time than when the money was borrowed. Even if it isn't, the term structure of rates is usually that higher rates go with longer terms. If you borrow money for 5 years but prepay in two years, the lender needs to find someone to borrow for 3 years at the same rate you borrowed for 5 years, adjusted for default risk of course. Otherwise the lender is not adequately compensated for the economic cost of the prepayment.
This re-investment risk is why lenders often impose prepayment penalties.
Another reason is that some lenders, instead of charging legal and other loan-related expenses as a lump sum fee due when the loan is created, will simply incorporate it into the interest rate on the loan. If the loan is prepaid, the borrower will then have not paid those costs back in added interest payments. The lender may impose a prepayment penalty in order to recover that loss.
You agreed to pay the loan as directed. Paying early is breaching that agreement. The bank would rather you just pay on time, as agreed, as they want to ensure their loan portfolios are predictable (whether held or packaged).
Clearly there is an undertone of "they are screwing you" in this post, which is misguided. The reality is you are trying to screw them, and they simply are not letting you.
You agreed to pay the loan as directed. Paying early is breaching that agreement. The bank would rather you just pay on time, as agreed, as they want to ensure their loan portfolios are predictable (whether held or packaged).
Clearly there is an undertone of "they are screwing you" in this post, which is misguided. The reality is you are trying to screw them, and they simply are not letting you.
Actually, I don't agree to prepayment penalties, but this is to me an annoyance worthy of objection. And yes, I do take the attitude of "they are screwing borrowers".
Some people would undoubtedly say that these borrowers need to manage their money better and build their credit. Which goal is defeated by the unnecessary and wasteful spending of prepayment penalties.
Yes they still exist, sometimes it isn't even called a prepayment penalty. I've seen it described as "The borrower will pay the lender for the amount of money the lender paid or credited to close the loan"
I'm going to spin this. The bank is going to give a person a very low interest rate, they invest the time, and man power, to give a borrower a great rate. The bank hopes to have this borrower pay interest over time so the bank has income. They may be looking at it long term. They want to ensure their return of investment by charging a prepayment fee, to account for everyone's time and money. When the loan gets paid off, they no longer get interest income.
I don't understand your pet peeve about a bank running their business as they want, isn't it a freemarket?
No, the banks don't want bad credit people to pay off the loan faster so they can lend out more money at a lower interest rate.
Yes they still exist, sometimes it isn't even called a prepayment penalty. I've seen it described as "The borrower will pay the lender for the amount of money the lender paid or credited to close the loan"
I'm going to spin this. The bank is going to give a person a very low interest rate, they invest the time, and man power, to give a borrower a great rate. The bank hopes to have this borrower pay interest over time so the bank has income. They may be looking at it long term. They want to ensure their return of investment by charging a prepayment fee, to account for everyone's time and money. When the loan gets paid off, they no longer get interest income.
I don't understand your pet peeve about a bank running their business as they want, isn't it a freemarket?
No, the banks don't want bad credit people to pay off the loan faster so they can lend out more money at a lower interest rate.
Actually I'm thinking of interest rates higher than mainstream bank rates, e.g. some years ago I had a finance company loan for a low-value used car - I did repay that loan early (paid a little extra wth every monthly payment and retired the loan one month early) and didn't notice any prepayment penalty.
Again, paying prepayment penalties is antithetical to sound personal finance. My spin is that it is analogous to kicking someone when they are down and trying to get up.
I haven't seen this in some years, but I assume prepayment penalties still exist.
Okay, I get the part about charging higher interest rates to those considered a high(er) risk. Fair enough.
If a person is such a high risk, one might expect a lender to be happy - even thrilled - when that high-risk borrower pays early. Wouldn't it be a reiief to get back with interest your money early, so that you could re-lend it to a more qualified borrower?
And when a lender drastically overestimates a borrower's risk, instead of the lender facepalm one might expect, the borrower gets to pay a huge prepayment penalty.
When I called my bank to ask about paying my car off early they told me there'd be no early pay off penalty. I had paid off over half of it but doubt that would make a difference.
Personally, I find the idea of a prepayment penalty predatory, considering they're mostly targeted at low income people with poor credit and limited knowledge of these matters.. and to add to the insult, having to pay a premium to pay off such a high interest loan early on. But as long as the prepayment penalty is clearly spelled out upon offering the loan, I don't see how it is unfair (just don't sign up for such a loan if its terms are so disgusting.) And for very low interest loans like for automobiles, I'd probably not care about a 1.5% rate since I'd be making far more investing that money than using it to pay off the loan.
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one might expect, the borrower gets to pay a huge prepayment penalty.
