In real estate definition, a prepayment penalty is the declared amount of fine should the borrower pay off the mortgage before the set payment date. It regulates how early and how much a borrower can return the money. Most loan providers allow at most 20% of the total debt including the interest.
The amount that is penalized is also taken by percentage from the mortgage balance. Likewise, the number of months left for the interest can and may be used as basis for the penalty.
What is the purpose of a prepayment penalty?
A prepayment penalty is added to any mortgage contract to ensure that the loaner gets to have their profit. Sometimes real estate buyers put their homes back on listing only a few years into the mortgage. To safeguard lenders from this risk, a prepayment penalty is imposed.
Subsequently, this also protects lenders when one completes their mortgage payment many years ahead in order to cut the amount of interests they should be originally paying.
Most importantly, borrowers should know every single detail of the prepayment penalty stated on their agreement with the lender. They should also know the two types of prepayment penalty; hard which covers both sale and refinancing, and soft which is only when refinancing a property.