What does the term 'prepayment penalty' refer to in mortgage loans?

The term 'prepayment penalty' specifically refers to a fee that lenders charge when borrowers pay off their mortgage loan earlier than the agreed-upon schedule. This penalty is intended to compensate the lender for the loss of interest revenue that would have been collected had the borrower remained in the loan for the full term. Prepayment penalties can be structured in various ways, including a percentage of the remaining balance or a fixed number of months' worth of interest.

Understanding this concept is crucial for borrowers, as prepayment penalties can affect the total cost of the loan and influence a borrower's decision to refinance or pay off their mortgage sooner than planned. Borrowers should carefully consider any potential penalties related to early repayment before entering into a mortgage agreement, as it can have a significant financial impact.