Prepayment Penalty

A prepayment penalty is a type of finance charge paid by a borrower for paying off a loan in advance. The prepayment penalty is common with certain mortgage loans, particularly subprime loans. Prepayment penalty terms are not standardized. A prepayment penalty may apply if too much extra principle is paid but not if the loan is paid off in full, or vice versa. Any prepayment penalty provision in a mortgage loan automatically makes that loan a non-conforming loan. The prepayment penalty is lucrative for some lenders. The borrower with poor credit will often take a high interest rate loan with a prepayment penalty if unable to qualify for any other loan. Later, when the borrower’s credit improves enough to refinance at a better rate, the prepayment penalty will kick in. For this reason, critics consider the prepayment penalty an abusive or even predatory lending practice.