Prepayment in Small Business Funding: What's Actually in Your Contract

#Prepayment is not a simple concept in small business funding

In consumer mortgages, prepayment rules are federally regulated and disclosed in a standardized format. In commercial small business funding, they are not, which means the same word ("prepayment") can mean five different things across five different products. Before accepting any offer, confirm exactly what happens if you want to pay off early.

#Factor-rate products: no discount, no penalty

This is the part most borrowers misunderstand. On a revenue-based advance or business cash advance priced with a factor rate, you owe the full factored amount regardless of how quickly you pay it off.

Advance $100,000 at a 1.30 factor, you owe $130,000. Pay it off in 3 months: still $130,000. Pay it off in 12 months: still $130,000. There is no early-payment discount because the total cost was fixed at origination, not computed on an accrual basis. The benefit of paying fast is simply that you become eligible for a new advance sooner and your daily ACH stops.

Some funders offer a "buyout discount" on the full remaining balance, negotiable, not guaranteed. Always ask.

#APR-based term loans: often a penalty

Term loans priced at an APR can include prepayment penalties structured in three ways:

• Flat percentage: A fixed percentage (e.g., 3%) of the outstanding balance at payoff
• Declining schedule: 3% if you pay in year 1, 2% in year 2, 1% in year 3, 0% after
• Yield maintenance: The lender calculates the interest income it would have earned over the full remaining term, discounted to present value. This is the most expensive prepayment structure and is more common in commercial real estate than in working capital

If you are likely to refinance or pay off within 12 months, avoid loans with flat or yield-maintenance prepayment penalties. The penalty can easily exceed the rate savings from refinancing.

#SBA loans: significant prepayment fees on long terms

SBA 7(a) and 504 loans carry prepayment penalties for the first 3 years: 5% in year 1, 3% in year 2, 1% in year 3, 0% thereafter. For a $1M SBA loan, a year-1 payoff triggers a $50,000 prepayment fee. Plan your SBA loan as a long-term hold; do not bridge into SBA with the intention of refinancing immediately.

#Lines of credit: usually no penalty

Most business lines of credit have no prepayment penalty on individual draws. You can pay down a draw on the line at any time, freeing that capacity for future draws. However, the line itself may have an annual fee, a non-usage fee, or an early termination fee if you close the line within 12 months of opening.

#What to ask before signing

• "Is there a prepayment penalty, and what is the formula?"
• "If I pay off in 90 days, what is my total repayment including any early payoff fees?"
• "Do I receive any discount for early payoff?"
• "What triggers the payoff window, can I pay off at any time or only on scheduled dates?"

One honest conversation before signing is worth weeks of confusion after. Our team walks every borrower through the payoff mechanics on every offer, contact us or apply here.