3 Reasons Why a Business Shouldn’t Pay Off Loans Early

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pexels-photo-210990You have a small-business loan and are thinking of paying it off early. Before you do, know that many small-business loans penalize early payoffs. The reason is that lenders want all their interest due over the full course of the loan. So, before you decide to pay that loan off early, read the small print. It may cost you more than you realize.

The Prepayment Fee

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Many small-business loans require all the interest and fees to be paid regardless of whether you pay off the loan early or on time. Some charge a 1 percent fee based on the original loan amount. The Small Business Administration charges a prepayment fee if the loan has a maturity of 15 or more years and is paid off during the first three years. Other lenders may charge a 1 percent fee for every year the loan is repaid early. Remember, lenders make their profit off the interest and fees charged on the loan and won’t give you a break if you pay it off early.

Check out online small-business loans. Many of those companies operate differently than banks and won’t charge the prepayment fee. Companies like Kabbage.com charge a monthly fee only on the amount you use. The fee is divided by the length of payments as set up, either six months or 12 months. So, each month you pay back the principal plus a monthly fee. There is no prepayment penalty.

Loans Are Not Amortized

When you take out a mortgage loan, the payments are set at the same amount every month. You pay most of the interest up front in the early years of the loan. This is called an amortized loan. Paying off this type of loan early saves you on interest. But, small-business loans are not set up that way. For example, you borrow $10,000, and the bank charges a total of $2,000 interest on a 12-month loan. If you pay the loan in total after six months, you still pay the full $2,000 in interest charges. There is no benefit to paying off the loan early, so why do it? In fact, if you look at the Annual Percentage Rate (APR), you are paying a higher APR by paying it off early since the interest is only spread over six months instead of a year.

You Lose the Tax Benefits

Another reason not to pay off your loan early is you will lose a tax deduction. The IRS allows the loan interest as a deductible, but once it is paid off, there is no longer a deduction. Many businesses prefer to take the deduction and make monthly loan payments and not pay off the loan early, even without early pay penalties. Check with your accountant or tax preparer to see if the deduction gives you a sizable benefit.

Remember, small-business loans are structured differently than personal loans. Paying off the loan early may not be the best use of your business cash. Prepayment penalties and fees will cost you more in the long run than just paying the monthly amount as the loan is paid out.

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