What is considered a "prepayment penalty"?

A prepayment penalty refers specifically to a fee that a lender charges a borrower if they pay off all or part of their loan before the scheduled maturity date. This type of penalty protects the lender's financial interests, as they lose out on interest income that they would have otherwise earned had the borrower continued making payments according to the original schedule.

In cases where borrowers refinance their loan or sell their property and pay off the existing loan early, the prepayment penalty serves as a deterrent against such actions, ensuring that lenders can receive a certain return on their investment. Such penalties can vary based on the lender's policies and the specific terms of the loan agreement.

The other answer choices do not accurately describe what a prepayment penalty is. Late payment fees relate to missed payments, closing costs refer to fees incurred during the purchase or refinance of a mortgage, and refinancing costs are entirely separate from the concept of prepayment penalties. Understanding the nuances of these fees is essential for borrowers to make informed decisions regarding loan agreements.