Wednesday, October 31, 2012

Little Known Facts: Prepayment Premiums

It is not unusual for a commercial loan agreement to include a provision which requires the borrower to pay a penalty in order to prepay the loan prior to maturity.  But would such a prepayment premium be considered "interest" under Texas usury law?

No.  Section 306.005 of the Texas Finance Code specifically excludes prepayment premiums from the definition of interest for the purpose of commercial loans in Texas.  The full text of the provision reads as follows:

“§306.005. PREPAYMENT PREMIUMS AND SIMILAR AMOUNTS.  With respect to a loan subject to this chapter, a creditor and an obligor may agree to a prepayment premium, make-whole premium, or similar fee or charge, whether payable in the event of voluntary prepayment, involuntary prepayment, acceleration of maturity, or other cause that involves premature termination of the loan, and those amounts do not constitute interest.”

Section 306.001(5) of the Texas Finance Code defines a “commercial loan” as “a loan that is made primarily for business, commercial, investment, agricultural, or similar purposes.  The term does not include a loan made primarily for personal, family, or household use.”

I hope everybody has a safe and happy Halloween.  My daughters are dressing up as a pirate and a Greek goddess.  I'm counting on sneaking one or two pieces of candy from their bags - but please don't tell them!