A prepayment penalty is a fee that some lenders charge if you pay off all or part of your mortgage early. Borrowers may think it is bizarre to be penalized for paying off a mortgage early, but lenders include prepayment penalties in mortgages to ensure they make money. If a lender goes to the trouble of loaning you money with interest, they expect to make money over time through payments of interest. If you pay off the loan early, then the lender loses out on further interest payments.
When considering different lenders, be on the lookout for prepayment penalties. They can be difficult to find in a lengthy mortgage, so it does not hurt to ask your lender if there is a prepayment penalty.
You should fully understand the prepayment terms of your loan since prepayment penalties can be written in a variety of ways. For instance, some are a fixed amount while others are based on a percentage of the remaining loan balance. Prepayment penalties can be confusing, so if you do not understand it, ask your lender or attorney for clarification.
It should be noted that prepayment penalties are not allowed in FHA, VA, and USDA loans.