Several types of retail and commercial loans include prepayment penalties assessed to borrowers who choose to pay off their loans early. We don’t charge prepayment penalties here at Actium Partners. We don’t think such penalties are good business, nor do we have a legitimate reason for implementing them.

If you’ve ever wondered why prepayment penalties exist, keep reading. We will explain everything you need to know about these fees. We will also explain in greater detail why Actium Partners doesn’t charge any kind of prepayment penalty on hard money or bridge loans.

A Basic Definition

A prepayment penalty is a charge assessed against a borrower who does not take his loan to its full term. The loan term is essentially the schedule of payments over a designated amount of time. Thus, the term of a 30-year loan is 30 years or 360 months.

If you were to take out a 30-year mortgage with a prepayment penalty attached, you would be charged an extra fee for paying off that loan any earlier. Some lenders charge a percentage. Other lenders charge a flat fee. Either way, the charge is a penalty for not carrying the loan for the entire 30 years.

Why Banks Charge Them

Not every bank charges prepayment penalties. And even among those that do, penalties are not assessed on every kind of loan. Prepayment penalties are usually reserved for mortgages, auto loans, and a few other types of financing including home equity loans.

So why do banks charge them? It’s all about interest. A bank makes money by charging interest on the money it loans. Paying off a loan early would deprive the bank of some of the interest it had planned to earn. But that’s just the start. There is also something known as ‘prepayment risk’ to consider.

Prepayment risk is a big problem in the mortgage lending business. For starters, understand that banks rarely hold on to the mortgages they make. Rather, they sell them to investors who package multiple loans and sell them as securities. The risk with these types of securities is that investors won’t get the expected return because loans are either paid off early or defaulted on.

Prepayment penalties protect investor profits by guaranteeing a set return even when homeowners pay off their mortgages early. The penalties are deemed necessary in order to sell mortgages as securities. Without the charges, banks would have a hard time selling their mortgages.

Why We Don’t Charge Them

Now that you know what prepayment penalties are and why banks charge them, you might already understand why we don’t follow suit. There are a couple of things to consider, beginning with the fact that we don’t sell our loans to third-party investors who package them.

By definition, hard money is private money. That mean entities like Fannie Mae and Freddie Max aren’t interested in buying and packaging our loans. Likewise, we have neither the need nor the desire to sell our loans to third parties. That means we don’t face nearly the same kind of prepayment risk. It is almost nonexistent to us.

The second thing to consider is this: it’s better for us to be repaid as quickly as possible because it allows us to reinvest our funds elsewhere. We neither need nor want our money tied up for long periods of time. Rather, we prefer to turn it over as quickly as possible so that we can invest in new projects.

Prepayment penalties are for banks. They aren’t for hard money lenders, which is why Actium Partners doesn’t charge them.