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Gephardt: Why Some Lenders Penalize Borrowers For Paying Off Loans Early

Feb 8, 2021, 6:15 PM | Updated: 9:23 pm

CLINTON, Utah – Let’s say you just received a stimulus payment or sold off that old car you inherited from your uncle. You might be thinking about using that money to pay off a loan or two.

And why not? Financial advisors often tell us to use unexpected windfalls to pay down debt. Some loans include a trap for people settling their debt early.

When a Clinton woman was told she owed tens of thousands of dollars for paying off her loan years ahead of schedule, she contacted the KSL Investigators.

Bonnie Sorbello had a new heating and cooling system installed in her home. We’re talking furnace, air conditioner and a humidifier. The total cost came to $21,875.

The contract was for 10 years of payments, but terms that long weren’t sitting well with Sorbello.

“My husband and I are getting older,” she said. “We may not be around in 10 years.”

Making bigger payments to pay off the debt earlier wasn’t an option, so Sorbello refinanced her home loan and money from that paid off her HVAC system 9.5 years early.

Then, an invoice came.

“It shows that I have paid it off, but I owe two early termination fees of $10,000 – well, a total of $22,000,” she explained.

Unbeknownst to her, the fine print on the back of the contract said there is an early termination fee: 100% of the total cost of the equipment if paid off in a year.

“I don’t know what to do,” Sorbello lamented. She decided it was time to call the KSL Investigators.

We took it to certified financial planner Shane Stewart with Deseret Mutual Benefits Administrators.

“Prepayment penalties are somewhat common,” he explained.

Stewart said most lenders count on interest to make them money on a loan. If you pay off your loan early, that’s money they lose. So, to recoup that loss, some lenders charge prepayment penalties.

Penalty amounts vary but Stewart couldn’t recall seeing one higher than 20% of the loan amount. He described the 100% penalty Sorbello faced as “outrageous.”

“I hope they take off our early termination fees,” said Sorbello.

We reached out to the HVAC company which told us they don’t charge prepayment penalties, period, and said this was all a misunderstanding due to a confusing invoice. The early termination fee in the fine print referenced cases where a customer was breaking the contract without paying the loan off.

Sorbello owed nothing.

While this case was a misunderstanding, it is an important reminder that prepayment penalties are a thing and worth looking into before making the call to pay off a debt early. They can be found in mortgages, personal loans, and consumer loans for stuff like new furnaces. 

Prepayment penalties must be disclosed in a document and verbally. (KSL-TV)

For a prepayment penalty to be valid, Stewart said it cannot just be tucked into a contract’s fine print.

“They have to be disclosed not only in the document but verbally mentioned to you,” he explained.

Stewart said the easiest way to avoid prepayment penalties is to look for loans that don’t have them. If you are already in a loan that has one, check to see if it allows partial payoffs without a fee. You might be able to make a partial payoff each year, penalty-free, to pay off the loan sooner.

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Gephardt: Why Some Lenders Penalize Borrowers For Paying Off Loans Early