What Is a Prepayment?

Prepayment is an accounting term for the settlement of a debt or installment loan in advance of its official due date. A prepayment may be the settlement of a bill, an operating expense, or a non-operating exꦕpense that closes an account before its due date. An individual, a corporation, or any otheꦉr type of organization may make a prepayment.

Understanding Prepayments

Debts and obligations can often get settled in advance through prepayment. Corporations might prepay rent, wages, 澳洲幸运5官方开奖结果体彩网:revolving lines of credit, or other sꦜhort-term or long-term debt ob꧅ligations.

Consumers can prepay credit card charges before receiving a statement. Or they might 澳洲幸运5官方开奖结果体彩网:pay a loan off early by refinancing the꧅ debt through another lender or by payꦡing the entire debt out of pocket.

Some loans, such as 澳洲幸运5官方开奖结果体彩网:mortgages, may include a prepayment penalty.▨ Lenders must disclose whether a loan includes a prepayment penalty, and borrowers must agree to the provision when they take out the loan. Further, some💟 state and federal laws restrict these types of prepayment penalties.

The penalty may only apply to paying off the entire balance, generally by 澳洲幸运5官方开奖结果体彩网:refinancing the mortgage. A borrower can usually make intermittent extra payments of the 澳洲幸运5官方开奖结果体彩网:principal without penalty.

Types of Prepayments

🏅Prepay🧜ments are common in a variety of contexts. Individuals and large businesses make prepayments.

Corporate Prepayments

In the corporate environment, expenses are the most common prepayments. These expenditures are paid in full in one accounting period for goods or services that will be consumed in a future period. The prepayment is reclassified as a normal expense when the asset is used or consumed. A prepaid expense is first categorized as a 澳洲幸运5官方开奖结果体彩网:current asset on the company's 澳洲幸运5官方开奖结果体彩网:balance sheet.

For example, a company can list $6,000 as a current asset under the prepaid rent account on its 澳洲幸运5官方开奖结果体彩网:balance sheet if it rents office space for $1,000 per month and prepays six months' rent. The company would reduce the current asset by $1,000 in each subsequent month and would list the expense on its 澳洲幸运5官方开奖结果体彩网:income statement as an operating cost of $1,000 as the total prepaid rent expenses are actually incurr🐬ed.

Prepayments by Individuals

Individuals also make prepayments, and the personal accounting process is much easier. A🌸 consumer might run up a monthly credit card bill with a settlement date of 30 days 🍸after the end of the month.

If a consumer incurs $1,000 of total expenses on the card and pays it off on the 30th day of that month, it's considered a prepayment because the bill isn't due for another 30 days. The consumer's credit card company tracks these prepayments, so there is little need for the consumer to account for it personally.

Prepayment by Taxpayers

Taxpayers regularly—voluntarily or not—make a prepayment of taxes when part of their pay gets withheld for taxes. Technically, taxes are due on or about April 15 each year, but their employers must withhold taxes in each pay period and send the money to the government on the employee's behalf.

The 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS) typically requires self-employed individuals to make a prepayment of taxes by filing quarterly estimated taxes.

In either case, if they pay more than their taxes due for tℱhe year, taxpayers receive any excess back as a tax refund.

What Is a Prepayment Penalty?

Some lenders charge a prepayment penalty if you pay off your loan early. Prepayment penalties typically amount to 1%-2%, which can add up quickly if you're making a substantial payment. Loan types that may include prepayment penaltiesﷺ include mortgages, auto loans, and personal﷽ loans.

Passed in 2010, the 澳洲幸运5官方开奖结果体彩网:Dodd-Frank Act prohibits lenders from assessing prepayment penalties on government-backed loans, including those from the 澳洲幸运5ꦿ官方开奖结果体彩网:Federal Housing Administration (FHA), the 澳洲幸运5官方开奖结果体彩网:U.S. Departmen🧜t of Veterans Affairs (VA), and the 澳洲幸运5官方ܫ开☂奖结果体彩网:U.S. Department of Agriculture (USDA).

For all other mortgage types, Dodd-Frank restricts lenders from assessing penalties beyond the first three years of the loan. Further, many states have la𒈔ws prohibiting p💯repayment penalties on mortgages and other loans.

Mortgage prepayment penalties generally only apply when you pay off the entire outstanding mortgage balance at once. Making additional payments toward the princi🦋pal rarely incꦰurs extra charges.

The Bottom Line

A prepayment is the settlement of a debt or expense before the agreed-upon payment date. Although individuals and companies make prepayments, individuals make them to minimize interest charg🎉es, while companies may prepay expenses as an accounting practice. Prepaid ren൩t counts as an asset on a corporate balance sheet.

Individuals might prepay installment loans such as mortgages and auto loans. However, some state and federal laws prohibit lenders from charging prepayme🌼nt penalties for certain loans. Be sure to check the loan terms in your contract before making𒁃 a prepayment.