What are typical consequences of a prepayment penalty?

A prepayment penalty refers to a fee that a borrower must pay if they repay their loan early, which can happen through refinancing or paying off the loan before its term ends. This penalty is often incorporated into the loan agreement as a way for lenders to safeguard their expected return on investment.

By imposing a fee for early loan payoff, lenders mitigate the risk of losing out on interest payments that they would have received over the life of the loan. This can be particularly common in fixed-rate loans where the lender has locked in a specific rate for an extended period. The prepayment penalty serves to discourage borrowers from paying off the loan early, thereby preserving the lender's anticipated income from interest.

Choosing a loan with a prepayment penalty might be beneficial for borrowers who plan to maintain their loan for a longer term but can be burdensome for those who anticipate needing to pay off their loan early. Thus, the correct identification of a fee for early loan payoff acutely captures the essence of how prepayment penalties function in real estate finance.