Prepayment Penalty Definition

A prepayment penalty is a fee, or penalty, that is assessed if a loan is paid off before its full term. Often attached to mortgage loans, prepayment penalties seek to discourage debtors from paying off the loan "too early"; in other words, the borrower wants to keep collecting interest on the loan.

Mortgage prepayment penalties are usually based on a percentage of the loan still outstanding or on a certain period of interest. Prepayment penalties are most-often attached to subprime mortgages with high interest rates, because borrowers will usually seek to refinance such mortgage loans as quickly as possible.