Definition - What does Prepayment Penalty mean?
A prepayment penalty is a penalty that a lender Imposes on a borrower for making loan payments before they are due. The reason why lenders often impose such penalties is because paying in advance prevents the lender from making the maximum profit from the interest. So, prepayment penalties compensate for these losses.
Justipedia explains Prepayment Penalty
An example of a prepayment penalty would be a bank who charges $2,000.00 to prepay a 10 year mortgage in seven years or less. By doing this, the bank guarantees itself at least an extra $2,000.00 of profits that it would otherwise lose to a fast payer. So, if a particular mortgage has a prepayment penalty on it then the borrower must decide if it is better for him or her to pay the loan back at a faster or slower rate.
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