What does "prepayment penalty" refer to in mortgage terms?

A prepayment penalty refers to a fee charged to borrowers for paying off their mortgage early. This provision is included in certain mortgage agreements to protect lenders from the loss of interest income when borrowers pay off their loans ahead of schedule. If a borrower pays off the mortgage, whether by selling the home, refinancing, or making significant extra payments towards the principal, the lender may impose this fee as a way to recoup some of the lost interest revenue.

Understanding this concept is crucial for borrowers to consider before entering into a mortgage agreement. It impacts decision-making regarding when to refinance or pay off a mortgage early. Knowledge of potential prepayment penalties empowers borrowers to make informed financial choices.