prepayment penalty
A fee charged by some lenders when a borrower pays off a loan before its scheduled maturity date, compensating the lender for lost interest income.
Example
“She wanted to refinance but discovered a 2% prepayment penalty on the existing mortgage would cost $8,000.”
Memory Tip
PREPAYMENT PENALTY = fee for paying off early. Always check before refinancing.
Why It Matters
Prepayment penalties can significantly increase the total cost of borrowing and limit your flexibility to refinance when interest rates drop or your financial situation improves. Understanding this fee helps you negotiate better loan terms and make informed decisions about whether to pay off debt early.
Common Misconception
Many people assume all loans have prepayment penalties or that these penalties are always illegal and unenforceable. In reality, prepayment penalties are optional terms that lenders may choose to include, and they are legal in most states, though regulations vary by loan type and location.
In Practice
A borrower takes out a 30-year mortgage for $300,000 with a 1% prepayment penalty clause. After five years, they want to refinance at a lower interest rate and pay off the remaining $280,000 balance early. The lender charges a prepayment penalty of $2,800, which the borrower must pay in addition to the remaining loan balance to avoid the penalty.
Etymology
PREPAYMENT (paying before due) PENALTY (fee for doing so). A PENALTY for PREPAYING the loan.
Common Misspellings
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See Also
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