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Prepayment Penalty
Definition
A prepayment penalty is a fee charged by a lender if you pay off a loan early, either partially or in full, before the scheduled term ends.
Explanation
Prepayment penalties protect lenders from losing interest income when borrowers pay off loans early. These penalties typically apply only during the first few years of a loan. They can be a fixed fee or a percentage of the outstanding balance.
Not all loans have prepayment penalties. When shopping for a mortgage, ask whether prepayment is allowed without penalty, especially if you plan to sell or refinance soon.
Example
A prepayment penalty of 2% on a $250,000 loan balance would cost $5,000 if you pay off the loan within the first three years.