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Simple English definitions for legal terms
prepayment penalty
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A quick definition of prepayment penalty:
Prepayment penalty: When you borrow money to buy a house, sometimes the bank will make you pay extra money if you want to pay back the loan early. This is called a prepayment penalty. The bank does this to make sure they don't lose out on the interest they would have earned if you had kept paying them for the full amount of time. The penalty can be a certain percentage of what you still owe, or it can be a certain number of months' worth of interest.
A more thorough explanation:
A prepayment penalty is a clause in a mortgage contract that requires the borrower to pay a fee if they pay off the loan early, usually within the first five years. This penalty is designed to protect the lender from losing out on interest income that they would have earned if the loan had not been prepaid.
For example, let's say you take out a mortgage for $200,000 with a prepayment penalty clause. If you decide to pay off the entire loan after only three years, you may be required to pay a penalty fee of several thousand dollars. This fee could be calculated as a percentage of the remaining mortgage debt or as a fixed number of months' interest.
Another example would be if you have a car loan with a prepayment penalty clause. If you decide to pay off the loan early, you may be required to pay a fee that is a percentage of the remaining balance or a fixed amount of interest.
In summary, a prepayment penalty is a fee that borrowers may be required to pay if they pay off a loan early. This penalty is designed to protect the lender from losing out on interest income.
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