Question

You expect to pay off your loan before its maturity date, so you made sure that the contract:

a) Does not contain a prepayment penalty clause
b) Provides for the use of the sum-of-the-digits method
c) Provides for the use of the Rule of 78s

Answer 1

The correct answer is letter "A": Does not contain a prepayment penalty clause.

Step-by-step explanation:

Prepayment penalties are included in loan agreements to ensure the financial institutions do not lose money in case a borrower decides to pay off the total debt earlier than dealt, before the debts' maturity date. Banks make money thanks to the interest rate they charge on loans. If debtors pay the entire amount of their debt before planned, banks would be losing to profit from interest.

Then, banks set prepayment penalties to provide the option to consumers to pay their debts before what the initial agreement says but protecting themselves from losing money in interest.