prepayment penalty
A prepayment penalty clause is common in mortgage contracts , and it specifies that if the borrower pays down or pays off the mortgage early, usually within the first five years of the loan , a penalty will be levied. Not all lenders charge prepayment penalties. When it is charged, it would become one of the conditions to end the mortgage early.
In some situations, prepayment penalty is usually applicable if the entire mortgage balance, or a large amount of the loan is paid off, or when trying to refinance a loan for a lower interest rate. In other situations, a lender may not require prepayment penalty as long as the home is not sold, meaning that payments that only cover extra principal early, or refinancing the loan, would not trigger prepayment penalty.
The prepayment penalty safeguards the lender from the loss of interest income that would have accrued if the loan had not been prepaid. The penalty is sometimes calculated as a percentage of the remaining mortgage debt , or as a fixed number of months' interest.
See: Justia - Prepayment Contract Clauses
[Last reviewed in March of 2025 by the Wex Definitions Team ]
Wex