A penalty imposed on the borrower for the complete settlement of the loan before the expected payoff date. It is means of compensation for the lender as the potential interest income is not realized. Also, the possibility of the reinvestment of the complete loan amount at a potentially lower interest rate is extinguished. An average penalty is approximately equal to the interest payments for three months on the loan amount.

More On This Topic

Link to This Definition
Did you find this definition of PREPAYMENT PENALTY helpful? You can share it by copying the code below and adding it to your blog or web page.
Written and fact checked by The Law Dictionary