Prepayment Penalty

DEFINITION of 'Prepayment Penalty'

A clause in a mortgage contract that says if the mortgage is prepaid within a certain time period, a penalty will be assessed. The penalty is usually based on percentage of the remaining mortgage balance or a certain number of months worth of interest.

A prepayment penalty that applies to both the sale of a home and a refinancing transaction is called a "hard" prepayment penalty. A prepayment penalty that applies to refinancing only is called a "soft" prepayment penalty.

BREAKING DOWN 'Prepayment Penalty'

Lenders write prepayment penalties into mortgage contracts to compensate for prepayment risk. As the incentive for a borrower to refinance a subprime mortgage is high, many subprime mortgages have prepayment penalties.

A borrower should be aware of the risks associated with a prepayment penalty. A prepayment penalty can substantially increase the cost of refinancing a mortgage when it would otherwise be economical.

RELATED TERMS
  1. Mortgage

    A debt instrument, secured by the collateral of specified real ...
  2. Prepayment Privilege

    The right given to a debt holder to pay all or part of a debt ...
  3. Subprime

    A classification of borrowers with a tarnished or limited credit ...
  4. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  5. Interest Rate Risk

    The risk that an investment's value will change due to a change ...
  6. Adjustable-Rate Mortgage - ARM

    A type of mortgage in which the interest rate paid on the outstanding ...
Related Articles
  1. Stock Analysis

    How to Analyze Facebook Stock (FB)

    Learn about the key drivers of Facebook's results that are important for investors, as these metrics will impact the stock price of the company.
  2. Credit & Loans

    College Loans: Private vs. Federal

    Not all student loans are the same. Know what you're getting into before signing on the dotted line.
  3. Insurance

    ARMed And Dangerous

    In a climate of rising interest rates, having an adjustable-rate mortgage can be risky.
  4. Credit & Loans

    How Mortgage Refinancing Affects Your Net Worth

    Find out how to determine whether refinancing will put you ahead or even more behind.
  5. Home & Auto

    The Benefits Of Mortgage Repayment

    Buying a home may be the biggest debt you'll ever incur. Learn why you should retire it sooner, rather than later.
  6. Credit & Loans

    Understanding The Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  7. Home & Auto

    Option ARMs: American Dream Or Mortgage Nightmare?

    Option adjustable rate mortgages could make or break your home-buying experience.
  8. Investing Basics

    Subprime Lending: Helping Hand Or Underhanded?

    These loans can spell disaster for borrowers, but that doesn't mean they should be condemned.
  9. Credit & Loans

    New Rules May Make It Easier to Get a Mortgage

    Fannie Mae and Freddie Mac have come to terms with lenders on how to solve mortgage disputes. This could be good news for people with lower credit ratings.
  10. Retirement

    Best Mortgage Companies Friendly to Retirees

    If you’re no longer in the workforce and need a loan to buy a home, which companies are the most welcoming? Plus, good news about qualifying for a loan.
RELATED FAQS
  1. What are the best ways to pay off my mortgage quickly?

    There are two main strategies for paying off a mortgage more quickly, which can be used alone or in tandem: making larger ... Read Full Answer >>
  2. Do FHA loans require escrow accounts?

    Federal Housing Administration (FHA) loans require escrow accounts for property taxes, homeowners insurance and mortgage ... Read Full Answer >>
  3. Do FHA loans have prepayment penalties?

    Unlike subprime mortgages issued by some conventional commercial lenders, Federal Housing Administration (FHA) loans do not ... Read Full Answer >>
  4. Can FHA loans be refinanced?

    Federal Housing Administration (FHA) loans can be refinanced in several ways. According to the U.S. Department of Housing ... Read Full Answer >>
  5. Can FHA loans be used for investment property?

    Federal Housing Administration (FHA) loans were created to promote homeownership. These loans have lower down payment requirements ... Read Full Answer >>
  6. Do FHA loans have private mortgage insurance (PMI)?

    he When you make a down payment from 3 to 20% of the value of your home and take out a Federal Housing Administration (FHA) ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center