The world of loans can feel like a treacherous one at times. There’s a lot to keep track of, and even more to watch out for. As you’ve navigated your own student loans, you may have come across the term “prepayment penalties.” But what does that mean? And, more importantly, how does it affect you?
What are prepayment penalties?
Prepayment penalties are usually imposed when borrowers start paying their payments before the agreed-upon deadline. While prepaying helps you, the borrower, save on accrued interest, it results in a loss for the lender. Lenders impose prepayment penalties to make up for this loss.
The good news is that prepaying student loans does not attract any prepayment penalties. (Thanks to the Higher Education Act of 2008). This goes for federal as well as private student loans. So if you have extra cash on you, you can pay the loan off early and reduce the amount of accrued interest without worrying about any penalty.
Is prepaying student loans a good idea?
Not always. Before you rush into prepaying your student loan, here’s something to think about. Student loans have some of the lowest interest rates. You’d be better off putting that extra money towards paying off (if you have them) your credit card debt, mortgage, or car loan, all of which have much higher interest rates.
Even if you don’t have any other debt, it may still make more sense to put the extra money to build an emergency fund or towards retirement savings rather than prepay your student loan.
Also take into consideration loan forgiveness. If you qualify for loan forgiveness you may want to hold off on that prepayment, as it reduces the amount of forgiveness that you qualify for.
Check out the other penalties just like paying off your student loans early.