What are prepayment privileges?
In a typical closed mortgage term, the borrower is unable to pay back the entire mortgage or increase mortgage payments without incurring penalties. After all, this is how lenders make money (unless a borrower has an open mortgage term).
However, most lenders will provide borrowers with the option, or privilege as they call it, to pay 10%, 15%, or 20% of the total principle amount each calendar year without incurring penalties.
For example, for a closed mortgage term of 5 years in the amount of $200,000.00, with a prepayment privilege to pay back 10% each calendar year without a penalty to the lender, the borrower is able to pay back $20,000.00 each calendar, which is the equivalent of 10% of the principle amount of the mortgage.
A borrower is also permitted to increase their mortgage payments by 10%, 15% or 20% each calendar year. For instance, for a closed mortgage term of 5 years in the amount of $200,000.00, with an interest rate of 3% and monthly payments of $948.42, with a prepayment privilege to increase monthly payment by up to 10% each calendar year without a penalty to the lender, the borrower is able to increase their monthly payment by $94.84, for a total amount of $1043.26.
These are both excellent options if a borrower wants to decrease the total amount of interest paid (or cost of borrowing) during the term and life of their mortgage.