What is prepayment penalty?

Jul 14, 2021

Kiritsis Law Group 212 922 0005

By: John Kiritsis, Esq., CPA, MBA, MS, JD, LL.M

Generally, a prepayment penalty would refer to a lender-imposed charge, when loan obligations are getting paid early.   A prepayment penalty could apply or be triggered, in both complete and partial loan prepayments. In many jurisdictions, a prepayment penalty can only be enforced, if the loan contract had a prepayment penalty cause at its time of execution. The rationale behind a prepayment penalty is that it compensates investors (the parties who own the mortgage notes) from reinvestment risk (they need to search and invest the prepayments into new investments, while losing their budgeted returns). Legal disputes over prepayment penalty clauses, are often triggered by lower interest rates. Depending on the loan contract language, a prepayment penalty maybe avoided, by structuring a real estate transaction differently. The presence or absence of a prepayment penalty, could influence a buyer’s decision to refinance, in order to take advantage of lower interest rates.

 

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