pixelseffect/getTyimages;Illustrated by Hunter Newton/Bankrate
Because the interest is how lenders make money, they often evaluate fees known as advance penalties for borrowers who repay business loans earlier than planned.
Prepaid penalties do not come with every loan, but it is important to know that they exist. Not only can they influence your decision to pay off your loan early, they can also affect the overall cost of business loans, especially SBA and commercial real estate loans.
Explore the types of small business loans that are generally responsible for advance penalties, how much they are, and when they are worth paying.
What is a business loan advance penalty?
A prepayment penalty is the business loan fee that the lender charges when the borrower pays the loan before the term ends. In addition to business loans, lenders often charge prepaid fees for mortgages and car loans.
This penalty compensates lenders for interest losses arising from early rewards. Lenders often calculate this fee based on the percentage of your loan balance.
What types of business loans impose prepayment penalties?
You may face advance penalties for business loans with certain SBA loans, particularly 7(a) and 504 loans and commercial real estate loans.
SBA 7(a) Loan
SBA 7(a) loans fund small businesses that cannot secure traditional loans. If the period is longer than 15 years, they will be punished with advance payment. The SBA advance penalty is triggered when you pay off a loan of 25% or more within the first, second or third year of the loan. The SBA total advance penalty decreases the longer you hold the loan. No advance penalties will be charged for more than three years.
| Loan year (from the date of receipt of the loan) | SBA loan repayment penalty |
|---|---|
| 1 year | 5.00% advance payment |
| 2 years | 3.00% of the advance payment amount |
| 3 years | 1.00% of the advance payment amount |
SBA 504 Loan
The SBA 504 loans, commonly used in commercial real estate projects, can also be prepaid fines. The terms of the loan are usually 10, 20, or 25 years, with a fine for early payments within 10 years. In the first year, the advance penalty equals the total interest rate on the loan. Then, the penalty is reduced by 10% each year until the 11th year when no penalty is charged.
| Loan Year | Prepaid penalty |
|---|---|
| 1 | Full interest on unpaid balance |
| 2 | 90.00% of interest |
| 3 | 80.00% of interest |
| 4 | 70.00% of interest |
| 5 | 60.00% of interest |
| 6 | 50.00% of interest |
| 7 | 40.00% of interest |
| 8 | 30.00% of interest |
| 9 | 20.00% of interest |
| 10 | 10.00% of interest |
| 11 and later | 0.00% |
Commercial Real Estate Loans
Commercial real estate loans are another type of business loan that can be used to purchase commercial real estate and involves prepaid penalties. Depending on the lender, if you pay the loan in full within a certain number of years, you may be subject to a prepayment penalty. However, for some lenders, the duration of your loan is not important, and early rewards will result in advance penalties.
With some commercial real estate loans, the defeasance clause allows borrowers to avoid paying advance penalties by allowing the borrower to replace the original collateral with another asset.
How can I find a business loan without prepaid penalty?
If you are applying for a business loan, ask your lender what prepayment penalty is. If you are going further into the process, carefully examine your loan agreement before signing it.
You can avoid prepaid fees by choosing an online and alternative lender, especially if you are applying for a short-term or fast business loan. However, you will need to check the other fees and interest charged by these loans as you may be charged higher fees elsewhere.
Business loans with no advance penalties
When is it worth paying your loan in advance?
Advance penalties on business loans can prevent borrowers from paying off their loans early, but there are situations where doing so can benefit. Consider the following scenario:
- High interest rate: If your loan has high interest rates, savings from early repayments can outweigh your prepayment penalty.
- Cash flow improvements: Early loan repayments can reduce monthly financial obligations, release cash, provide more flexibility and improve cash flow.
- Improved terms for future borrowing: Early repayment of your loan can improve your creditworthiness and facilitate future financing with more favorable terms.
Conclusion
When you are looking for the best business loan, it is essential to understand the terms and know that you will be charged a prepayment penalty. Careful evaluation and comparison of loan options can help you make informed decisions. While advance penalties on business loans affect flexibility when it comes to repayments, there are benefits to paying off your loan early. If this is a wise move for your business, don’t let the fees hinder you from the profits of early repayments.
