What is a prepayment penalty?

Personal loans have become one of the fastest growing debt categories in the U.S. thanks to their ease of use, quick funding and flexibility when it comes to how the money can be used. For instance, personal loans can be used to pay for a wedding, a vacation, a funeral, a medical bill, a home repair, renovations and more. Many people also use personal loans as a means to consolidate their debt, and you can typically borrow up to $100,000, depending on your creditworthiness and the maximum amount allowed by the lender.

But there's still a lot you should know about personal loans before you decide to take one on. Like any other form of debt, personal loans are paid back monthly with interest. But that may not be the only fee you're charged. Some personal loan lenders also charge origination fees and late payment fees, but one other, and more odd, fee you should be aware of is a prepayment penalty.

Below, CNBC Select breaks down what you need to know about prepayment penalties on a personal loan, including how much they cost and how to tell if the loan you're applying for carries this fee.

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A prepayment penalty (also known as an early payoff fee) is an additional fee charged by some lenders if you pay off your loan early. All personal loans come with a specified loan term — a.k.a. the amount of time you have to completely repay the loan balance (plus interest) you borrowed.

Loan repayment terms can typically range from six months to seven years, but each lender has their own requirements for repayment that can differ by a few months or a few years. For example, Marcus by Goldman Sachs Personal Loans allows borrowers to repay their loan in as little as three years and as long as six years (36 to 72 months). SoFi Personal Loans, though, gives borrowers two to seven years to repay their loan amounts (24 to 84 months).

So let's say you're approved for a personal loan with a prepayment penalty and the lender says you have a repayment term of four years (48 months); you'll have to make fixed, equal monthly payments with interest for 48 months to repay the amount you borrowed. However, if you pay more than the amount that is due each month, you'll end up paying off the loan before the 48 months are up and you'll be charged a prepayment penalty.

The actual cost of a prepayment penalty will vary depending on how it's being charged. It can be charged in one of three ways:

• As a percentage of your loan balance
• As the amount of interest your lender is missing out on since you paid off the loan early
• As a fixed fee

Because of this, the prepayment penalty can cost you anywhere from a few hundred to a few thousand dollars, depending on how much you borrowed and how the fee is being charged. So although paying off your loan early can help you save on interest charged, you may in-turn trigger a prepayment fee.

Make sure to do the math before you pay off your loan early. If you're almost done paying off a personal loan balance and want to prepay the rest of what you owe, make sure to look at the cost of the fixed prepayment fee versus the remaining interest left on the loan. It's possible it could be cheaper to continue making monthly payments versus paying the fixed fee.

Not all personal loan lenders charge a prepayment penalty. In fact, some — like LightStream and Discover — don't charge any additional fees at all.

Be sure to read the loan agreement so you're aware of all fees and how they'll be charged. But if you still aren't sure if you'll be charged a prepayment fee, you can always ask the lender directly.

There's a lot to learn about personal loans, including the terms and fees. The prepayment penalty is one fee you should be aware of if you're considering using a personal loan to fund some large expenses.

Most importantly, though, you should always make sure you're comfortable with all the terms and charges of the loan before you sign on the dotted line — and never borrow more than you can afford to repay.

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