What is the purpose of a pre-payment penalty in a mortgage loan?

What is the purpose of a pre-payment penalty in a mortgage loan?

• A. To discourage early repayment of the loan.
• B. To lower the interest rate of the mortgage.
• C. To offer lender protection in the event of default.
• D. To increase the loan term.

Answer: (A)

The purpose of a pre-payment penalty in a mortgage loan is to discourage early repayment of the loan. Lenders include this penalty as a clause in the loan agreement to ensure that they receive a certain amount of interest income from the borrower before the loan is paid off. When a borrower pays off their mortgage early, especially if they refinance to a lower interest rate, the lender may lose the expected future interest payments, which is why they introduce a penalty for early repayment. This mechanism helps lenders manage their risk and predict their revenue, maintaining stability within their lending practices.

The purpose of a pre-payment penalty in a mortgage loan is to discourage early repayment of the loan. Lenders include this penalty as a clause in the loan agreement to ensure that they receive a certain amount of interest income from the borrower before the loan is paid off. When a borrower pays off their mortgage early, especially if they refinance to a lower interest rate, the lender may lose the expected future interest payments, which is why they introduce a penalty for early repayment. This mechanism helps lenders manage their risk and predict their revenue, maintaining stability within their lending practices.