Auto Loans Tips For Avoiding Prepayment Penalties

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, - May 26, 2016

Avoiding prepayment penalties is important for borrowers who finance or lease a new vehicle but choose to pay the remaining balance in full before the term stated on the contract ends. Not all auto loans include prepayment penalties, while others do, so it is important to speak directly with your prospective lender or with a finance director at your dealership if you have any questions.

For loans that do not include a prepayment penalty, it is common to expect a slightly higher interest rate (around .25%). However, by shopping around or stating that you may take your business elsewhere, you should be able to find a lender without a prepayment penalty that does not mark up the interest rate. With auto lending, captive lenders — those directly connected to an auto manufacturer — do not normally have prepayment penalties and, coincidentally, they also offer the best low- or no-interest loans on many vehicles.

If you do find yourself prepared to sign a finance contract that includes a prepayment penalty, think twice about it. If you plan to keep the vehicle until it is paid off and also make payments for the full term, a loan with a prepayment penalty may be a fine choice. Otherwise, if you pay the loan off early, you will find yourself responsible for a penalty that is typically 1% of the remaining principal balance. Sometimes there is also a minimum prepayment penalty, between $200 and $300, that is assessed.

Depending on your lender, you may be able to avoid the prepayment penalty in a fashion beyond waiting for the entire loan term to lapse. You may choose to make a large principal payment to reduce your remaining principal balance to $1,000. When your principal is down to $1,000, request a payoff fax or email from your lender to confirm the amount. Then payoff your loan, which has a balance of only $1,000. If your prepayment penalty is calculated based on 1% of the principal, your prepayment penalty will amount to $10. While it isn’t completely avoiding the prepayment penalty, it is minimizing another pesky bank fee.

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You may also wish to negotiate with the bank before you sign the contact. While negotiating away a pre-payment penalty will be impossible with a dealership, as dealerships use indirect lending and are merely acting on behalf of the lenders instead of being the lending company themselves, this may be a good option if you are working directly with a loan officer. Another option would be to negotiate a rate discount if they will not remove the prepayment penalty. Even a small rate discount over the course of a loan could offset the one-time prepayment penalty you will make.

An auto loan broker or a dealership finance professional will be able to look at the options offered by many lenders and could help you find a loan without a prepayment penalty. As a dealership is an indirect lender, they may have access to 20 or 30 regional and national lenders that range the gamut from having to not having prepayment penalties. If at all possible, avoid a prepayment penalty because, while it seems small, the penalty is at its core just another bank fee that constitutes profit for the lender.


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