What is a prepayment penalty?

A prepayment penalty is a fee charged by a lender if a borrower pays off their mortgage — fully or in part — before a specified period has elapsed. The penalty is designed to compensate the lender for interest income it expected to receive over the life of the loan. Prepayment penalties can be structured in various ways, such as a fixed dollar amount, a percentage of the remaining balance, or a sliding scale that decreases over time.

Prepayment penalties are relatively uncommon in standard residential mortgages today, particularly for conventional loans — federal regulations have significantly restricted their use on primary residence loans. However, they can still appear on certain loan products, including some commercial loans, hard money loans, or seller-financed arrangements. Buyers in the Western Catskills considering any non-traditional financing for rural properties in Delaware, Otsego, Greene, or Ulster counties should ask directly about prepayment terms before signing any loan agreement. Retaining the flexibility to pay down or refinance without penalty is generally in the buyer's best long-term interest.