What is prepayment clause for a mortgage loan?


Here is what a prepayment clause is for a mortgage loan - this is the right of borrower (mortgagor) to pay off the loan early, fully or partially, before its term is due.

A popular prepayment clause will include lender's agreement that no more than 20% of the original loan amount is prepaid in any year of the mortgage term.

Another prepayment clause will include provisions for permission of full outstanding principal prepayment for, say, 2% pre-payment penalty.

Despite that many mortgage loans have penalty clauses for prepaying their loans, many borrowers actually opt for paying off mortgage loan early.

Why are mortgage prepayments done so often?

There are usually three types of consumers, looking for early loan prepayment.

  1. While there are borrowers out there with great credit and of low risk to the lender, there are many bad credit borrowers who are pressed to take bad credit loans. While subprime lending is a great resource for many whose credit score or nonexistent credit history, some lenders misuse their position of power over those consumers and force them into loans with predatory terms and/or rates.

    Often, when discovering how unfavorable their mortgage terms are, borrowers with a subprime loan choose to refinance despite the prepayment penalty. That is, if they could afford to.

  2. Another type of borrowers disregarding loan prepaying clauses are investors and experienced borrowers, who are completely aware of their mortgage terms, and use their negotiating power when taking out a mortgage. That type of consumers would typically manage to avoid a prepayment penalty, or negotiate one for limited period and more favorable interest rate.
  3. There is also the dream of homeownership and fully paid off mortgage is not to be neglected. Many borrowers would simply try to pay off their mortgage on accelerated terms, disregarding whether this is going to be a good financial decision simply because they want to get rid of mortgage debt as soon as possible.
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