Prepayment Penalty

What is a 'Prepayment Penalty'

A prepayment penalty is 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. Prepayment Privilege

    The right given to a debt holder to pay all or part of a debt ...
  2. Prepayment

    The satisfaction of a debt or installment payment before its ...
  3. Single Monthly Mortality - SMM

    In mortgage-backed securities (MBSs), this is the percentage ...
  4. Prepayment Model

    A model used to estimate the level of prepayments on a loan portfolio ...
  5. Constant Percent Prepayment

    Annualized estimate of mortgage loan prepayments, computed by ...
  6. Public Securities Association Standard ...

    An assumed monthly rate of prepayment that is annualized to the ...
Related Articles
  1. Bonds & Fixed Income

    The Risks Of Mortgage-Backed Securities

    Find out how weighted average life guards against prepayment risk.
  2. Professionals

    Mortgage-Backed Securities (MBS)

    CFA Level 1 - Mortgage-Backed Securities (MBS). Learn the process of creating and collateralizing mortgage-backed securities. Covers their expected cash flows and possible risks.
  3. Options & Futures

    Subprime Is Often Subpar

    Proceed with caution when considering these short-term, high-interest mortgages.
  4. Professionals

    Collateralized Mortgage Obligations (CMOs)

    FINRA Series 7 Online Study Guide Section 4
  5. Should You Pay Down Your Mortgage Early?

    At some point, you’ve probably heard the common wisdom that you should head into retirement without a mortgage to worry about. But the reality is that 40% of individuals who are between ...
  6. Real Estate

    Best 3 Mortgage Calculator Websites for Canadian Residents

    Understand the key features of Canadian mortgages, and discover a few of the best online mortgage calculators for Canadian home loans.
  7. Investing

    3 Major Risks For Annaly’s Investors

    Thanks to its double-digit dividend yield, Annaly Capital Management has long been a favorite among income-seeking investors.
  8. Professionals

    Call and Prepayment Risk

    CFA Level 1 - Call and Prepayment Risk. Learn the sources of call and prepayment risk and why it can occur. Highlights the disadvantages of investing in prepayable or callable bonds.
  9. Options & Futures

    Defeasance Reduces Commercial Real Estate Fees

    Try this alternative to short-term variable-rate financing when using leverage to buy property.
  10. Professionals

    Mortgage-Backed Securities

    Mortgage-Backed Securities
RELATED FAQS
  1. I made involuntary contributions to a retirement plan while temporarily employed. ...

    Your options depend on the type of penalty that would apply. If the penalty is a surrender charge or another penalty that ... Read Answer >>
  2. Do prepayments provide working capital?

    Learn how prepayments for various services such as insurance, rent and supplies are included as part of a company's current ... Read Answer >>
  3. Do FHA loans have prepayment penalties?

    Learn whether FHA loans have prepayment penalties, and find out the rules governing interest charges when prepaying your ... Read Answer >>
  4. Does the IRS charge interest on penalties?

    Understand whether or not the IRS charges interest on penalties. Learn about the types of penalties that can be assessed ... Read Answer >>
  5. Are IRS penalties tax deductible?

    Learn about penalties assessed by the U.S. Internal Revenue Service and how the IRS does not taxpayers to deduct them on ... Read Answer >>
  6. Are there penalties for withdrawing monies invested in annuities?

    Learn about the penalties associated with taking early withdrawals from an annuity. Steep penalties are assessed by the insurer ... Read Answer >>
Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center