What is prepayment of loan?
As the name suggests, it describes the early settlement of a loan obligation. This may come about for any number of reasons, from a windfall gain for the borrower to a refinancing of the loan at lower interest rates.
Where have you heard about prepayment of loans?
As an investor, you may have been made aware by your financial adviser of the benefits of early loan repayment, chiefly the ability to avoid future interest payments. You may also have read about prepayment of loan in the financial media or considered repaying some of your loans early.
What you need to know about prepayment of loans.
Prepayment of loan can apply to most types of debt obligation, but is often associated with early payment of mortgages. Low interest rates in recent years have encouraged many people to refinance their home-loans at reduced cost, prepaying the original loan and taking out another.
Prepayment mattered less when mortgages remained on the books of the institutions that originated them, because the prepayment could be recycled into a new mortgage. But the trend towards bundling up mortgages and other loans and selling them to investors makes prepayment a potential problem because it denies those investors the future stream of interest payments that they had been expecting. For this reason, some mortgages and other loans now include financial penalties for those who seek to pay them off early.