All You Need to Know about Prepayments and Extensions

All You Need to Know about Prepayments and Extensions
All You Need to Know about Prepayments and Extensions
October 20, 2016

All borrowed money must be paid back at some point. The key issue when it comes to repayment is to ask if the loan achieved the purpose for which you took it, if not, will there be room for an extension? Understanding how loan payment works is a vital key to accessing loan investments.

The payment structure is the same across board

Loan repayment usually takes on of two forms- either the borrower pays the monthly interest along with a certain amount of the initial money borrowed or they pay the monthly interest and pay the initial amount of money borrowed in a lump sum at the exhaustion of the agreement period. Investors know this and will probably insist on sticking with the status quo.

Read also: Merits and Demerits of Purchase Money and Non-purchase Money Loans in Short Sales

Standard loan documents make provision for the borrower to pay off loan

When a standard loan document is being prepared, there is a provision for the borrower to pay off the loan before its due date and often includes a clause stipulating if the borrower can seek for an extension to the loan maturation time. These are rare conditions that go off the usual terms of a loan agreement.

Many reasons may warrant a borrower to prepay or seek for extension

A borrower may decide to utilize their right of prepayment even when the loan maturation has not reached. In the same way, a borrower may seek an extension if they still have needs yet to be met. No matter the decision of the borrower, the investor needs to have in mind that they will be affected in one way or the other.

Read also: A Cash Business Loan might Just be Perfect for a Working Capital

Seeking for extension will tie up the investor’s money

When a borrower is seeking for an extension, one thing is certain – the investor’s money will remain committed to the borrower’s project for more period of time than initially agreed upon. Some investors may grant the extension without altering the initial agreement while others will seek for a renegotiation.

Extension time is usually stated in the agreement

If a loan makes provision for extension, the extension time will be indicated on the agreement. For example, a loan may have a maturation time of one year with an extension of three to six months. What this means is that the borrower can seek for an extension of at most six months after the maturation date. The borrower will continue to pay interest but the lump sum will be paid at the end of the six months extension.

Read also: What You Never Knew about the Small Business Administration Loans

Lock-out period blocks prepayment option

A loan agreement may have a lock-out period and prepayment penalties. The main aim of lock-out period is to prevent the borrower from paying back the loan before the agreed date. A prepayment penalty is usually enacted by a lender when a borrower pays back a loan earlier than expected because this will stop the lender from getting the anticipated interest. When loan agreement does not have a lock-out period, it means that the borrower can decide to pay back at any time before the maturation date.

Lenders can invest in other loan offerings when borrower pays off early

Lock-outs and prepayment penalties are more in commercial real estate than in residential real estate. The flexibility of residential real estate has been attested by various homeowners. Investors should not mourn the expected loan interest they miss when a loan is repaid early, rather, they should invest their money into other loan offerings – and many of them are opening up daily.

Read also: Looking for Ways to Finance Your Company: Try Asset Based Lending

Article highlights

  • Most loan documents give room for extension.
  • A borrower may decide to pay off a loan before the due date.
  • Interests are either paid monthly or together with the lump sum at the expiration of the loan.
  • Loan extension is usually for 3 to six months.
  • The decision of the borrower directly affects the investor’s money.
  • When a borrower seeks for an extension, it means the investor’s money will be tied up.
  • Payment of loan before the due date will make the investor lose money in the form of interest.
  • Payment of loan before the due date is not allowed by some investors.
  • Payment of loan before the due date may attract some penalties.
  • Lock-out period is more in commercial real estate than in residential real estate.

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