A prepayment penalty is what a borrower owes for paying a loan off before maturity. It exists because the lender priced the loan expecting a stream of interest, and ending it early takes that away. It appears as a declining percentage of the balance, as yield maintenance, or as defeasance.
- Read the structure, not the word. A step-down percentage, yield maintenance and defeasance can differ by an order of magnitude in cost.
- It is negotiated when the loan is made, when nobody is thinking about selling. That is exactly when to think about it.
- Most structures have an open window near maturity where the penalty disappears. Know the date; it may be worth waiting for.
- It is a real closing cost on a sale, so it belongs in the seller's net sheet from the first pricing conversation.
Selling a year before maturity, on a balance of $947,300, with a penalty of 3% assumed at that point in the schedule.
Twenty-six thousand dollars is not a fee for breaking a promise. It is the lender buying back the yield it priced, and it is negotiable at origination, not at closing.
Related terms
All termsLoan Maturity
Maturity is the date the loan must be repaid in full, regardless of how the property is performing.
FinanceCash-Out Refinance
A cash-out refinance replaces an existing loan with a larger one and hands the owner the difference.
FinanceBalloon Payment
A balloon payment is the unamortised balance that comes due in one sum when a loan reaches the end of its term.
Terms arrive with the writing.
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