Prepayment

Definition

A Prepayment is the payment of an account before it is due. Many types of debts can be settled in advance through a prepayment.

The type of debts that can be settled through prepayment is, for example, rent and insurance must be prepaid ahead of their start dates. People can also make prepayments on their credit card balances before the bill comes due which keeps interest payments down.

A mortgage prepayment is when an extra payment is made on your mortgage. Prepayment means that the money will go directly toward reducing the balance on the mortgage. Mortgages are structured over life of the loan for instance 30 years. This monthly payment is fixed, which means it will not change over the life of the loan. However, the interest portion of each monthly payment and the part of the monthly payment that goes towards the principal will vary each month. When a prepayment is made, that money goes directly to the principal of the mortgage, which helps pay the mortgage down faster.

Mortgages, however, impose a penalty for prepayments. The penalty usually only applies when paying off the entire balance for example during a refinancing. Buyers are usually able to make intermittent prepayments without penalty.

Prepayment kept simple

Prepayment is when you pay off a loan or a part of a loan before it becomes due. Paying some or all of a debt ahead of the due date will bring down the principal amount owing and any interest fees owed.  Some debts are required to be prepaid, for example, rent. Rent must be prepaid ahead of time.

How does Prepayment apply to you

If you purchase a home and get a mortgage for $500,000 your monthly payment at a 4.5% interest rate will be $2300 a month. At the end of the term, you will still owe $450,000, if at that time at renewal you decide to prepay another $50,000 your mortgage left owing will be $400,000 and your monthly payments will be lower. Usually, there will be no prepayment penalty at that time. However, if you decide halfway through the term that you want to put down another $50,000 without waiting for the renewal period you may incur penalties that will need to be paid as well.

Share this to help everyone get a better understanding of finance

Facebook
Twitter
LinkedIn
WhatsApp

Be the first to try the app

Sign-up and get exclusive access to try the app when we launch. It’s time to control your finance.

About us

Control all aspects of your finances. Learn about what you need to know to make smart decisions. But most of all, have trust that we’re here to help. In the end, you’ll have more time to do what you love.
Chango - Unifying your financial world. | © 2018 Chango Card Inc.

Rethinking personal finance

Subscribe to be part of the next wave in finance

Upgrade your finances.

Keep informed with the most important financial terms. Explained without any jargon.Learn how to budget for a debt free life and how to get the best out of the Chango financial wellness and budgeting app.