DEFINITION of 'Prepayment Privilege'

The right given to a debt holder to pay all or part of a debt prior to its maturity or ahead of schedule, usually without risk of penalty. Prepayment privileges are often elements of such debts as mortgages or automobile loans. They are in opposition to a prepayment penalty, which is the amount set by the lender as a penalty to the debtor for paying off a debt prior to its maturity in order to recoup a portion of the lost interest the lender had planned to earn.

BREAKING DOWN 'Prepayment Privilege'

Fixed-income securities that incorporate prepayment privileges are considered riskier to the debt holders because they are not certain as to when they will receive the cash flow of incoming funds. Prepayment tends to occur when interest rates are low and mortgage refinancing is viewed as favorable.

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