Definition
A prepayment privilege is a borrower’s right to pay off their mortgage loan early or make additional payments toward the principal without incurring penalties. This feature allows homeowners to reduce interest costs and loan duration over time.
Explanation
Not all mortgages allow unlimited early payments without penalties. A prepayment privilege enables borrowers to:
✅ Make lump-sum payments toward the principal.
✅ Increase monthly payments to reduce total interest.
✅ Pay off the mortgage early without penalty fees.
Some loans have restrictions on prepayment:
- Fixed-percentage limits (e.g., only 20% of the mortgage balance can be prepaid per year).
- Time-based restrictions (e.g., no prepayments allowed in the first 3 years).
- Prepayment penalties on certain loans, especially subprime mortgages or commercial loans.
Benefits of Prepayment Privileges:
- Lower total interest costs over the life of the loan.
- Faster equity building for homeowners.
- Early financial freedom by eliminating mortgage debt sooner.
Example
A homeowner has a 30-year mortgage of $300,000 at a 5% interest rate. By making an extra $500 payment each month, they can:
- Reduce loan term by 7 years.
- Save over $60,000 in interest payments.