Pre-Payment Penalties Are Often Allowable

            Money Lending has been around for thousands of years.  And regulation of money lending has also been around for thousands of years.  Some of the oldest known regulations for money lending are found in the earliest parts of the Bible at the Book of Exodus, where certain restrictions are made against charging interest on loans of money.  But in today’s world, loans are bought and sold like many other commodities.  It’s therefore not surprising that many laws and regulations have been passed concerning the lending and borrowing of money.

One regulation about money lending that may be unknown to some people is the lender’s ability to charge a penalty for early repayment of a loan.  At first glance, this may seem like an odd thing.  Lenders generally make loans with an expectation that the loan amount will eventually be repaid with interest.  If a borrower is able to repay a loan early, it could seem like a lender might be very interested in accepting a borrower’s early payments.

But a key aspect of money lending is time.  Interest is generally computed based on the passage of time.  If a lender makes a loan and the borrower repays early, then the lender may lose the interest that would have accrued on the loan.  In addition, tax considerations are often based on time as well.  Repayment of a loan with interest in any given year may create a markedly different tax result for the lender than repayment in a later year.

All of these considerations can play a part in a lender’s decision to include a “prepayment penalty” with a loan.  A “prepayment penalty” provision generally provides that if a borrower repays a loan early, then the borrower will pay a “penalty” for making the early payment.  Such “penalty” is generally in addition to all of the interests, fees, points and other charges that the borrower would have already paid in connection with such loan.

This kind of arrangement can seem burdensome to borrowers.  After all, many borrowers only seek loans because they don’t have the necessary cash to buy a home, a lot, or some other goods.  The borrower already has paid or will pay the lender fees and interest – adding a prepayment penalty can add to the financial burden already being experienced by a borrower.

But California law allows lenders to charge prepayment penalties. For example, it’s possible for a lender to absolutely prohibit early repayment of a loan.  One California court has noted that “in the absence of a statute a debtor has no more right to pay off the obligation prior to its maturity date than he does to pay it off after its maturity date.”  Williams v. Fassler (1980) 110 Cal. App. 3d 7, 10.  In the alternative, many lenders can charge a “fee” or a premium in exchange for agreeing to accept early payment.

Copyright 2023 ROBERT B. JACOBS