What is Prepayment Penalty?

A prepayment penalty is a charge some lenders apply when a customer pays off a vehicle loan early, either in full or with large extra payments. It compensates the lender for interest it would have earned over the remaining term. In Canada, many auto loans are open, meaning they can be prepaid without penalty, but some contracts, particularly certain fixed-rate or subprime products, may include prepayment charges or interest calculated in ways that reduce the benefit of paying early. Dealers and F&I managers should be able to tell customers whether their financing is open or closed and explain any prepayment terms clearly. Buyers who expect to sell, refinance, or pay off a vehicle ahead of schedule need this information to choose the right loan product.