What is the penalty called that is imposed on a borrower for paying off the loan early?

A prepayment penalty is a fee that lenders may impose on borrowers who pay off their loans before the agreed-upon maturity date. This penalty is designed to compensate the lender for the loss of interest income that would have been earned had the borrower continued to make regular payments until the end of the loan term. By including a prepayment penalty, lenders can mitigate the financial risk associated with early loan repayment, which can impact their overall revenue.

It's essential to note that not all loans have prepayment penalties, as some lenders may choose to offer loans without these fees to attract more borrowers. However, when a prepayment penalty is stipulated in a loan agreement, it becomes a crucial aspect for borrowers to consider before refinancing or paying off a loan early. Understanding this concept helps borrowers make informed financial decisions regarding their loans.