Prepayment Definition


Prepayment is

  • The premature payment of all or part of a debt. Prepayment means paying off due balance partially or entirely before the loan term expires. Prepayment is done with the purpose of accumulating less interest for the borrower. That is why lenders often include a prepayment penalty in the mortgage agreement as to offset loss as much as possible.
  • Payment exceeding the scheduled repayment amount.

Within the mortgage business, prepayment is related to a prepayment penalty that may be invoked on many occasions. The prepayment penalty comes as percent of the remaining balance at the time prepayment occurs, or as interest for a number of months. The prepayment penalty is usually disregarded or waived after the sixth year of the loan.

Types of Prepayment Penalty

  • hard prepayment penalty - A prepayment penalty on sale and refinancing will be a hard one.
  • soft prepayment penalty - If it applies to refinancing only, it will be a soft one.

If you are a prime borrower, you may not even have a prepayment penalty as you probably have a good rate; if you have one you should try to negotiate the prepayment penalty in return for reduction of the rate.

If you are a subprime borrower, chances are you are given a very high interest rate and will always have a prepayment penalty inserted in the contract as your lender will not want to miss on that loan and will be afraid you may build enough credit to refinance into a prime loan, so you definitely should try to negotiate terms.

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