A prepayment penalty is a fee that lenders charge for paying off a mortgage loan early.
Lenders practice this to recoup some of the interest income that is lost due to the early pay off.
Most mortgage loans do not carry prepayment penalties, but you should always ask your lender and double check your paperwork to be sure. In practice, prepayment penalties only apply if you pay off the entire balance of the mortgage. This could occur by simply refinancing or selling the property. Prepayment penalties only occur during the first three to five years of the mortgage.
If you are considering a mortgage with a prepayment penalty, read the fine print carefully. If you think you will sell your home or refinance within he next three to five years, then another mortgage that is prepayment penalty free would suit you better.
Usually, the prepayment penalty is based on a percentage of the remaining balance of the mortgage or a certain number of months worth of interest.