Some auto loans have what are known as prepayment penalties attached to the contract as a provision. If this is the case for your auto loan, you would be wise to know for sure. If you don’t already know, you can find out by reading through the entirety of your loan contract. It may be printed in veiled language, but if there is a penalty clause, you will be able to find it.

Prepayment Penalties

There are a number of different ways to penalize borrowers for attempting to pay back their loans early. A legitimate
question is: Why would lenders penalize borrowers for being responsible?

Lenders make their money on the interest of a loan. They lend you an amount known as the principal. As the time goes by, interest accrues on that amount which represents the lender’s profit. If you were to pay off your principal sooner than they anticipate, they lose out on interest charges, making the loan less profitable for them. For better or for worse, some lenders include penalties in contracts should you attempt to do this.

One penalty form included in some contracts is basically front-loaded interest. This type of clause loads the first payments with all of the interest for the whole loan. Even if you pay it off one year early, you’ve still paid all the interest.

Another type of contract requires you to agree to pay all of the interest and principal regardless of how fast you pay the loan off.

A third type of penalty is more obvious. It forces you to pay a percentage of whatever balance remains–or would have remained if you had not paid it off.

Auto loans can be confusing and include penalty clauses that make it difficult to pay off the loan early. The best thing you can do is to read the contract before you sign. If there is a prepayment penalty–in any form–that you don’t like, walk away and find another lender.