Prepayment

Financial Dictionary -> Loans -> Prepayment

Prepayment is a blanket term used to describe any form of payment that is before an agreed time or before rather than after a service is given (e.g. prepaid credit card). Prepayment is most commonly discussed in regards to loans and mortgages.

In the case of a loan or mortgage, prepayment is the partial or complete repayment of the loan before it is due in the terms of the contract. This may manifest as several monthly payments paid off in one month, or the entire remainder of the loan paid off years in advance. There are many reasons why a borrower might do this, mainly just to get rid of debt in a timely fashion. Nobody likes being in debt. However although it seems like a positive thing, to pay back the money you borrowed, most lenders are against this and impose a penalty if you wish to make a prepayment.

In the case of credit cards, prepayment is an option given by financial institutions to borrowers that are highly unlikely to be given a loan or credit card due to years of bad debt and credit history. Because loaning the money is very risky, they allow the borrower to pay the money up front in return for a faux credit card that has a positive balance. It can be used just like a regular credit card, but once the prepaid amount is used up, it can no longer be used unless the borrower tops it up with more prepaid credit.

It may seem strange that somebody with money upfront would then use it to buy a credit card, but in today's society many forms of payment require the use of a credit card, so this is the only option for those that have a poor credit history.